jemoi13
Nov 15, 2010, 03:12 AM
Hello I am struggling to find the NPV of the following exercise as I can not identify the revenues:
An Operation Manager is about to put forward a proposal to replace an existing production line costing £6000 K. The new line will have a economic life of 5 years and is estimated to realise £1200 K in scrap value at the end of that period. Its operating cost would be £2000 K per year.
Alternatively, the existing machinery could be overhauled and modernised at a cost of £1600 K. The Operation Manager estimates that operating costs would then be £2900 K per year. In this case the extended operation life is also expected to be 5 years, the scrap value of the old production line would be £600 K whether it was sold now or in 5 years.
The output potential of the new line or the renovated line will be the same.
The corporate tax rate is 30% and tax is assessed on the next pre tax cash flow in the relevant year. The company is expected to remain in profit for tax purposes throughout the period in question.
You may ignore inflation. The appropriate discount rate for either possibility would be 8%.
You may assume that doing neither is not a realistic option. The company would lose sales profitability very quickly if forced to continue with un-modernised equipment.
Required:
Prepare a short report that assess whether the new production line should purchased or whether the old one should be modernised. Explain the logical step in making your analysis (how you chose your analytical method and/or why you rejected other possible methods).
An Operation Manager is about to put forward a proposal to replace an existing production line costing £6000 K. The new line will have a economic life of 5 years and is estimated to realise £1200 K in scrap value at the end of that period. Its operating cost would be £2000 K per year.
Alternatively, the existing machinery could be overhauled and modernised at a cost of £1600 K. The Operation Manager estimates that operating costs would then be £2900 K per year. In this case the extended operation life is also expected to be 5 years, the scrap value of the old production line would be £600 K whether it was sold now or in 5 years.
The output potential of the new line or the renovated line will be the same.
The corporate tax rate is 30% and tax is assessed on the next pre tax cash flow in the relevant year. The company is expected to remain in profit for tax purposes throughout the period in question.
You may ignore inflation. The appropriate discount rate for either possibility would be 8%.
You may assume that doing neither is not a realistic option. The company would lose sales profitability very quickly if forced to continue with un-modernised equipment.
Required:
Prepare a short report that assess whether the new production line should purchased or whether the old one should be modernised. Explain the logical step in making your analysis (how you chose your analytical method and/or why you rejected other possible methods).