Question
(‘JJ) uses a certain machine to produce car jacks. The machine cost the company $90,000 three years ago. The reduced book value now stands at $60,000. A new model of the machine is currently available for $139,350. The new machine has a useful life of five years, at which time it will be sold for $20,000.
Using the new machine, the expected unit sales of the car jacks would be 6,000 car jacks per annum. The estimated unit selling price is $35 for the first year.
As a result of the COVID-19 pandemic in Singapore, JJ is experiencing labour shortage. JJ will have to transfer workers from another department to the new project. These workers earn a contribution of $2 per direct labour hour in their original department. The fixed overhead cost would be $2.20 per hour and this is expected to remain unchanged.
JJ’s products are being sold to a distributor. The sales agreement allows the selling price to rise at the rate of 10 percent per year after the first year. The unit cost price, except for fixed costs, is expected to increase at the same rate as the selling price.
Working capital requirements are expected to be $15,000 in the first and second years, increasing to $18,000 in the third year and is expected to remain at this level till the end of the project. All the amounts of working capital will be recovered at the time of project termination.
The new project uses cutting-edge technology and so enjoys a tax holiday from the authorities. The drawback of using this high-risk approach is that the new project requires a minimum return of 27 percent per annum.
Required:
Identify the relevant cash flows for the decision as to whether JJ should proceed to purchase the new machine.
Sample Solution
