A Plastic manufacturer has under consideration the proposal ofproduction of high
ID: 2661683 • Letter: A
Question
A Plastic manufacturer has under consideration the proposal ofproduction of high quality plastic glasees. The necessary equipmentto manufacture the glasses would cost Rs 80,000. The productionequipment would last five years with no salvage value. The glassescan be sold at Rs 3/- each. Regardless of level of production, themanufacturer will incur cash cost of Rs 27,000 each year. Thevariable cost is estimated at Rs 2.0 per glass. The manufacturerestimates it will sell about 75000 glasses per year, the straightline method for depreciation will be used; the ordinary tax rate is55%. Should the proposed equipment be purchased? Assume cost ofcapital is 12%.
Explanation / Answer
Equipment cost = 80000
Life – 5 years
Depreciation straight line method
No salvage value
Depreciation= (cost-salvage value) /life
= (80000-0)/5 = 16000
Sale value of each glass = 3 Rs.
Cash cost =27000 each year
Variable cost = 2 Rs. Per glass
Selling Units = 75000 glasses per year.
Tax = 55%
Cost of capital = 12%
PVCF5years 12% =3.604776
1 to 5 years (i.e. each year):
Sales(75000*3) (A) 225000
Fixedcost 27000
Variable cost(75000*2) 150000
Profit before Tax (A)-(B) 32000
Less: Tax55% 17600
14400
Add:Depreciation 16000
Cash inflows aftertax 30400
PVCF5years12% 3.604776
Present value of Cash Inflows after tax (30400*3.604776) =109585.
Cost = 80000
Income = 109585
Income>cost so we can accept the project
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