Should the company proceed with buying the new machine

Assignment Help Financial Accounting

Reference no: EM132737930

GSFM7514 Accounting & Finance For Decision Making - UNITAR International University

Question 1
Rose-Jewel sells jewellery through retail stores throughout the country. Over the last two years it has experienced declining profitability and is wondering if this is related to the sector as a whole. It has recently subscribed to an agency that produces average ratios across many businesses. Below are the ratios that have been provided by the agency for Rose-Jewel's business sector based on a year end of 30 September 2019.

Return on year-end capital employed (ROCE) 16.8%

Net asset (total assets less current liabilities) turnover 1.4 times

Gross profit margin 35%

Operating profit margin 12%

Current ratio 1.25:1

Average inventory turnover 3 times

Trade payables' payment period 64 days

Debt to equity 38%

The financial statements of Rose-Jewel for the year ended 30 September 2019 are:

Income Statement Revenue	RM'000	RM'000 56,000
Opening inventory	8,300
Purchases	43,900
	52,200
Closing inventory	(10,200)	(42,000)
Gross profit		14,000
Operating costs		(9,800)
Finance costs		(800)
Profit before tax		3,400
Income tax expense		(1,000)
Profit for the year		2.400
Statement of financial position
	RM'000	RM'000
Assets
Non-current assets
Property and shop fittings		25,600
Deferred development expenditure		5,000
		30,600
Current assets
Inventory	10,200
Bank	1,000	11,200
Total assets		41,800

Equity and liabilities Equity
Equity shares of RM1 each		15,000
Property revaluation reserve		3,000
Retained earnings		8,600
		26,600
Non-current liabilities
10% loan notes		8,000
Current liabilities
Trade payables	5,400
Current tax payables	1.800	7,200
Total equity and liabilities		41.800
Total equity and liabilities

Required:
a) Prepare the equivalent ratios that have been provided by the agency for Rose-Jewel.
b) Assess the financial and operating performance of Rose-Jewel in comparison to its sector averages.

Question 2
Two years ago, your company purchased a machine used in manufacturing for RM140,000. Although the machine had performed as expected, you have learned that a new machine is available that offers many advantages; you can purchase it for RM150,000 today, plus an additional RM10,000 in shipping and RM5,000 training costs. The new machine will be depreciated on a straight-line basis over five years and has no salvage value.

You expect that the new machine will produce a gross margin (revenues minus operating expenses other than depreciation) of RM40,000 per year for the next five years. Upon buying the machine, it requires inventories to increase by RM20,000 and accounts payable increase by RM10,000. The change in Net Operating Working Capital is expected to be fully recovered at year five.

The current machine is expected to produce a gross margin of RM20,000 per year. The current machine is being depreciated on a straight-line basis over a useful life of 7 years, and has no salvage value, so the depreciation expense for the current machine is RM20,000 per year. The market value today of the current machine is RM90,000.

Your company's tax rate is 28% and the beta factor of this new investment is 1.5. The company has a target capital structure of 50% equity and 50% debt. The cost of debt after-tax is 8%. The risk-free rate is 4% and the market risk is 8%.

Required:
a) Would you argue for the cost of shipping and training to be included in the calculation of initial cash outflow? Justify your answer.
b) What is the cost of equity for the new project?
c) Calculate the initial cash outflow associated with replacing the older printing machine with the new machine.
d) Calculate the Net Present Value (NPV) if the company decided to buy the new machine.
e) Should the company proceed with buying the new machine?

Reference no: EM132737930

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