Broughton Ltd. manufactures and sells one product with a projected contribution margin of $17.00 for year 1. The total budgeted fixed costs are $925,000. Selling prices and variable costs are projected to increase by 8% per year, while fixed costs are forecast to grow at a rate of 5% per year. Existing production capacity is 105,000 units.
The probability distribution on its forecasted demand is as follows:
The company is considering purchasing a new machine which will increase its production capacity by 30,000 units. The machine costs $175,000 with a residual value of $40,000 after its useful life of 5 years. The applicable Capital Cost Allowance rate is 20%. The company's tax rate is 40% and it requires an after-tax rate of return on capital of 10% (including provision for inflation).
Required:
Should Broughton purchase the new machine based on NPV analysis? Assume the machine will be sold on January 1 of year 6 for tax purposes.

Question

Broughton Ltd. manufactures and sells one product with a projected contribution margin of $17.00 for year 1. The total budgeted fixed costs are $925,000. Selling prices and variable costs are projected to increase by 8% per year, while fixed costs are forecast to grow at a rate of 5% per year. Existing production capacity is 105,000 units.
The probability distribution on its forecasted demand is as follows:
  The company is considering purchasing a new machine which will increase its production capacity by 30,000 units. The machine costs $175,000 with a residual value of $40,000 after its useful life of 5 years. The applicable Capital Cost Allowance rate is 20%. The company's tax rate is 40% and it requires an after-tax rate of return on capital of 10% (including provision for inflation).
Required:
Should Broughton purchase the new machine based on NPV analysis? Assume the machine will be sold on January 1 of year 6 for tax purposes.

Quizplus · Accepted Answer

The Answer of Broughton Ltd. manufactures and sells one product with a projected contribution margin of $17.00 for year 1. The total budgeted fixed costs are $925,000. Selling prices and variable costs are projected to increase by 8% per year, while fixed costs are forecast to grow at a rate of 5% per year. Existing production capacity is 105,000 units.
The probability distribution on its forecasted demand is as follows:
  The company is considering purchasing a new machine which will increase its production capacity by 30,000 units. The machine costs $175,000 with a residual value of $40,000 after its useful life of 5 years. The applicable Capital Cost Allowance rate is 20%. The company's tax rate is 40% and it requires an after-tax rate of return on capital of 10% (including provision for inflation).
Required:
Should Broughton purchase the new machine based on NPV analysis? Assume the machine will be sold on January 1 of year 6 for tax purposes.