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Calculation of NPV and before tax on capital employed
Asked Oct 16, 2008, 02:36 AM
Kimathi company plan to buy a new machine to meet expected demand for new product T. this machine will cost Kshs.250,000 and last for four years, at the end of which time it will be sold for Kshs.5,000. Kimathi company expects demand for product T to be as follows:
Year 1 2 3 4
Demand (units) 35,000 40,000 50,000 25,000
The selling price for product T is expected to be Kshs.12 per unit and the variable cost of production is expected to be Kshs.7.80 per unit. Incremental annual fixed production overheads of Kshs.25,000 per year will be incurred. Selling price and cost are all incurrent price terms.
Selling price of product t: 3% per year
Variable cost of Product: 4% per year
Fixed production overheards: 6%
Kimathi company has a real cost of capital of 5.7% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year.
Kimathi Company has a target return on capital employed of 20%. Depreciation is charged on a straight line basis over the life of an asset.
a. calculate the NPV of buying the new machine and comment on your findings ( Work to the nearest Kshs.1,000)
b. Calculate the before tax return on capital employed (accounting rate of return) based on the average investment and comment on your findings.
c. Discuss the strength and weaknesses of internal rate of return in appraising capital investments.