Uftin Co is a large company which is listed on a major stock market. The company has been
evaluating an investment proposal to manufacture Product K3J. The initial investment of $1,800,000 will be payable at the start of the first year of operation. The following draft evaluation has been prepared by a junior employee.
The junior employee also provided the following information:
1. Relevant fixed costs are forecast to be $150,000 per year.
2. Sales and production volumes are the same and no finished goods inventory is held.
3. The corporation tax rate is 22% per year and tax liabilities are payable one year in arrears.
4. Uftin Co can claim tax allowable depreciation of 25% per year on a reducing balance basis on the initial investment.
5. A balancing charge or allowance can be claimed at the end of the fourth year.
6. It is expected that selling price inflation will be 4·2% per year, variable cost inflation will be 5% per year and fixed cost inflation will be 3% per year.
7. The investment has no scrap value.
8. The investment will be partly financed by a $1,500,000 loan at 10% per year.
9. Uftin Co has a weighted average cost of capital of 12% per year.
Required:
(a) Prepare a revised draft evaluation of the investment proposal and comment on its financial acceptability. (11 marks)
(b) Explain any TWO revisions you have made to the draft evaluation in part (a) above. (4 marks)