The directors of EMY plc are currently considering an investment in a new production machinery to replace an existing one. The new machinery would produce goods more efficiently, leading to increased sales volume. The investment required will be GH¢1,150,000 payable at the start of the project. The alternative course of action would be to continue using the existing machinery for a further five years, at the end of which time it would have to be replaced. The following forecasts of sales and production volumes have been made: Sales in units Year Using existing machinery Using new machinery GH¢ GH¢ 1 400,000 560,000 2 450,000 630,000 3 500,000 700,000 4 600,000 840,000 5 750,000 1,050,000 Production in units Year Using existing machinery Using new machinery GH¢ GH¢ 1 420,000 564,000 2 435,000 637,000 3 505,000 695,000 4 610,000 840,000 5 730,000 1,044,000 Further information 1) The new machinery will reduce production costs from their present level of GH¢7.50 per unit to GH¢6.20 per unit. These production costs exclude depreciation. 2) The increased sales volume will be achieved by reducing unit selling prices from their present level of GH¢10.00 per unit to GH¢8.50 per unit. 3) The new machinery will have a scrap value of GH¢150,000 after five years. 4) The existing machinery will have a scrap value of GH¢30,000 at the start of Year 1. Its scrap value will be GH¢20,000 at the end of Year 5. 5) The cost of capital to the company is 12% per annum. Required 1. Prepare a report to the directors of EMY plc on the proposed investment decision. 2. List any further matters which the directors should consider before making their decision.
The directors of EMY plc are currently considering an investment in a new production machinery to replace an existing one. The new machinery would produce goods more efficiently, leading to increased sales volume. The investment required will be GH¢1,150,000 payable at the start of the project.
The alternative course of action would be to continue using the existing machinery for a further five years, at the end of which time it would have to be replaced.
The following
Sales in units
|
Year |
Using existing machinery |
Using new machinery |
|
|
GH¢ |
GH¢ |
|
1 |
400,000 |
560,000 |
|
2 |
450,000 |
630,000 |
|
3 |
500,000 |
700,000 |
|
4 |
600,000 |
840,000 |
|
5 |
750,000 |
1,050,000 |
Production in units
|
Year |
Using existing machinery |
Using new machinery |
|
|
GH¢ |
GH¢ |
|
1 |
420,000 |
564,000 |
|
2 |
435,000 |
637,000 |
|
3 |
505,000 |
695,000 |
|
4 |
610,000 |
840,000 |
|
5 |
730,000 |
1,044,000 |
Further information
1) The new machinery will reduce production costs from their present level of GH¢7.50 per unit to GH¢6.20 per unit. These production costs exclude depreciation.
2) The increased sales volume will be achieved by reducing unit selling prices from their present level of GH¢10.00 per unit to GH¢8.50 per unit.
3) The new machinery will have a scrap value of GH¢150,000 after five years.
4) The existing machinery will have a scrap value of GH¢30,000 at the start of Year 1.
Its scrap value will be GH¢20,000 at the end of Year 5.
5) The cost of capital to the company is 12% per annum.
Required
1. Prepare a report to the directors of EMY plc on the proposed investment decision.
2. List any further matters which the directors should consider before making their decision.
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