The directors of EMY plc are currently considering an investment in a new production machinery to replace an existing one. The new machinery would produce goods more efficiently, leading to increased sales volume. The investment required will be GH¢1,150,000 payable at the start of the project. The alternative course of action would be to continue using the existing machinery for a further five years, at the end of which time it would have to be replaced. The following forecasts of sales and production volumes have been made: Sales in units Year Using existing machinery Using new machinery GH¢ GH¢ 1 400,000 560,000 2 450,000 630,000 3 500,000 700,000 4 600,000 840,000 5 750,000 1,050,000 Production in units Year Using existing machinery Using new machinery GH¢ GH¢ 1 420,000 564,000 2 435,000 637,000 3 505,000 695,000 4 610,000 840,000 5 730,000 1,044,000 Further information 1) The new machinery will reduce production costs from their present level of GH¢7.50 per unit to GH¢6.20 per unit. These production costs exclude depreciation. 2) The increased sales volume will be achieved by reducing unit selling prices from their present level of GH¢10.00 per unit to GH¢8.50 per unit. 3) The new machinery will have a scrap value of GH¢150,000 after five years. 4) The existing machinery will have a scrap value of GH¢30,000 at the start of Year 1. Its scrap value will be GH¢20,000 at the end of Year 5. 5) The cost of capital to the company is 12% per annum.
The directors of EMY plc are currently considering an investment in a new production machinery to replace an existing one. The new machinery would produce goods more efficiently, leading to increased sales volume. The investment required will be GH¢1,150,000 payable at the start of the project.
The alternative course of action would be to continue using the existing machinery for a further five years, at the end of which time it would have to be replaced.
The following
Sales in units
|
Year |
Using existing machinery |
Using new machinery |
|
|
GH¢ |
GH¢ |
|
1 |
400,000 |
560,000 |
|
2 |
450,000 |
630,000 |
|
3 |
500,000 |
700,000 |
|
4 |
600,000 |
840,000 |
|
5 |
750,000 |
1,050,000 |
Production in units
|
Year |
Using existing machinery |
Using new machinery |
|
|
GH¢ |
GH¢ |
|
1 |
420,000 |
564,000 |
|
2 |
435,000 |
637,000 |
|
3 |
505,000 |
695,000 |
|
4 |
610,000 |
840,000 |
|
5 |
730,000 |
1,044,000 |
Further information
1) The new machinery will reduce production costs from their present level of GH¢7.50 per unit to GH¢6.20 per unit. These production costs exclude
2) The increased sales volume will be achieved by reducing unit selling prices from their present level of GH¢10.00 per unit to GH¢8.50 per unit.
3) The new machinery will have a scrap value of GH¢150,000 after five years.
4) The existing machinery will have a scrap value of GH¢30,000 at the start of Year 1.
Its scrap value will be GH¢20,000 at the end of Year 5.
5) The cost of capital to the company is 12% per annum.
Required
1. Prepare a report to the directors of EMY plc on the proposed investment decision.
2. List any further matters which the directors should consider before making their decision.
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