Mutually Exclusive Projects Considered:
Mutually Exclusive Projects Considered:
Status Quo (A) Continue to use existing own equipment and supplement production capacity by leasing additional equipment.
Alternative (B) Purchase new plant and equipment. No leasing required if the replacement is undertaken.
Business Operations Details
Old Plant and Equipment New Plant and Equipment
Current book value $0 Acquisition cost $2,000,000
Remaining life (years) 5 Life (years) 5
Variable costs 60% of sales Variable costs 55% of sales
Leasing costs $280,000 Leasing costs $0
Associated operating expenses $200,000 Associated operating expenses $120,000
Insurance $35,000 Insurance $20,000
Annual depreciation Fully depreciated Annual depreciation $400,000
Accounting salvage value $0 Accounting salvage value $0
Expected salvage value if sold today
($0 if sold 5 years later) $100,000
Expected salvage value $400,000
The corporate tax rate is 30% and the required rate of return is estimated to be 10% for your company. The rates of return given are in real terms. The projected inflation rate is 4%. All expenses and costs are expected to grow at the same rate as inflation.
Sales Projections (already adjusted for inflation):
Year 1 2 3 4 5
Estimated sales with existing fleet ($, Millions) 5.5 6.0 6.7 6.5 6.3
Estimated sales with new fleet($, Millions) 7.2 7.5 8.0 8.0 8.0
Sensitivity Analysis to be Undertaken:
Discount rates at:
10%
12%
17%
Sales scenarios:
sales increase by 10% each year
sales decrease by 10% each year
You are also informed that the management of the company is not happy with the service provided by the agency from which it leases its equipment; reliability and timeliness issues have been identified. The business growth potential appears to be significant and stability in provision of plant and machinery is desired.
