Strategic and Financial Decision Making (ACFI5022)
Spion ltd makes components for electronic equipment and has recently tendered for a contract to supply a low cost item to a satellite navigation equipment manufacturer.
In order to produce the component Spion would have to purchase a special machine at a cost of £560,000, at the end of 2017. It is expected, due to the obsolescence of such equipment as satellite navigators, that the contract to manufacture the component will only last for 4 years. After that time it is thought that the machine will not have a great deal of use and will only be disposed of for £10,000.
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Demand for the component is expected to be a follows:
2018 2019 2020 2021
Demand (units) 38,000 42,000 50,000 23,000
The selling price of the component is expected to be £22.00 per unit and the variable cost of production will be £15.00 per unit with incremental annual fixed overheads of £70,000. All of these forecasts are quoted in current terms.
The general rate of inflation over the relevant period is expected to be 5% per year but Spion has forecast that its selling price and costs will inflate as follows each year:
Selling price 3% per annum
Variable cost of production 4% per annum
Fixed production overheads 6% per annum
Spion is aware that its investors are expecting a real rate of return of 5.7% per annum.
The company operates with a target Return on Capital Employed of 20% and depreciation is charged on a straight line basis over the life of an asset.
Strategic and Financial Decision Making (ACFI5022) 代写
a) Calculate the net present value of buying the machine and comment on your findings.
b) Calculate the accounting rate of return (based on average investment) of the investment and comment on your findings.
c) Spion’s Sales Director is heard to say, “Let’s base our decision on the Average Accounting Rate of Return outcome as this measurement is linked to Return on Capital Employed with which we are familiar. I don’t understand the meaning of NPV. Or at least we could calculate the Internal Rate of Return and then we could use the percentage return in order to judge project acceptability.”
You should provide a response to the Sales Director which will recommend a method to use and compare and contrast the three appraisal methods in question.
(Total 35 marks)