Reference no: EM13386598

Polycorp Limited Steel Division is considering a proposal to purchase a new machine to manufacture a new product for a potential three year contract. The new machine will cost $1.11 million. The machine has an estimated life of three years for accounting and taxation purposes. The contract will not continue beyond three years and the equipment estimated salvage value at the end of three years is $108,000. The tax rate is 30 percent and is payable in the year in which profit is earned. An investment allowance of twenty percent on the outlay is available. The cost of capital is 13.65%pa. Addition net working capital of $70,000 is required immediately for current assets to support the project. Assume that this amount is recovered at the end of the three year life of the project. The new product will be charged $53,000 of allocated head office administration costs each year even though head office will not actually incur any extra costs to manage the project. This is in accordance with the firm’s policy of allocating all corporate overhead costs to divisions. Extra marketing and administration cash outflows of $43,500 per year will be incurred by the Steel Division. An amount of $39,000 has been spent on a pilot study and market research for the new product. The projections provided here are based on this work. Projected sales for the new product are 32,000 units at $125 per unit per year. Cash operating expenses are estimated to be 78 percent of sales (excludes marketing and administration, and head office items). Except for initial outlays, assume cash flows occur at the end of each year (unless otherwise stated). Assume diminishing value depreciation for tax purposes.