2)Please answer with workings.. Tqvm Question 2 Funtime Co manufac.docx - 2)Please answer with workings Tqvm Question 2 Funtime Co manufactures safety

2)Please answer with workings.. Tqvm Question 2 Funtime Co manufac.docx

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2)Please answer with workings.. Tqvm Question 2 Funtime Co manufactures safety surfacing for children's playgrounds. The main raw material required is rubber particles and these are currently purchased from an outside supplier for $3.50 per tonne, fixed for the next four years. If the contract is terminated within the next two years, Funtime Co will be charged an immediate termination penalty of $150,000, which will not be allowed as a tax deductible expense. The directors are considering investing in equipment that would allow Funtime Co to manufacture these particles in-house by using recycled tyres. The machine required to process the tyres will cost $400,000, with a residual value of $50,000 after 4 years. The costs associated with the new venture are as follows: - Variable costs (per tonne produced) $0.80 - Fixed costs (per annum) $192,500 The additional fixed costs include maintenance costs of $40,000 and the additional depreciation charge (calculated on a straight-line basis over the life of the asset) relating to the machine. All of the above figures are quoted in current day
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Unformatted text preview: terms. Inflationary increases are expected as follows: Variable costs: 3% per annum Maintenance costs: 5% per annum - Other fixed costs: 2% per annum The annual demand for the particles (based on the sales forecasts of the company) is: Year 1 Year 2 Year 3 Year 4 Demand (in tonnes) 100,000 110,000 130,000 160,000 Corporation tax of 30% per year will be payable one year in arrears. Tax-allowable depreciation on a 25% reducing balance basis could be claimed on the cost of the equipment, with a balancing allowance being claimed in the fourth year of operation when the machine is disposed of. Required: (a) Using 15% as the after-tax discount rate, advise Funtime Co on the desirability of purchasing the equipment. (Your workings should be shown to the nearest $000.) (20 marks) (b) Explain the advantages of the payback method of investment appraisal over discounting methods (NPV and IRR) and suggest in what situations the payback method might be preferred (5 marks) (Total 25 marks)...
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  • Fall '17
  • Bob Maxwell

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