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Peter is an owner of a factory and is evaluating the prospects of investing in a new industrial equipment. This new equipment will help improve the quality of the factory output, while also enhancing productive efficiency.
For such an equipment to be purchased, government license is required and Peter has already acquired this license at a cost of $4,000.
This equipment will cost $30,000 to acquire and will be immediately put into operation, upon acquisition. As a result of the improved production flexibility and more diverse production capabilities, it will enable the factory to enjoy incremental sales of $20,000 per annum from production of greater product varieties. At the same time, factory operating costs will increase by $8,000 per annum.
Due to the size of the equipment, Peter will need place the new equipment at his spare factory space, which can be rented out at anytime for $5,000 per annum.
Required:
a. Calculate the net present value of the investment in the new industrial equipment.
(8 marks)Can anyone solve this question?
Incomplete question as the cost of capital or WACC isn’t provided, also isnt mentioned its life, though that can be considered as a perpetuity bt a wacc or Ke is imp. Other than that its like this
Sales 20000
VC (8000)
FC (5000)
contribution 7000Now this is the point where you have to find its present value (ignoring tax, scrap proceeds etc) n then deduct that amount from cost of equipment 30000
Isnt 5000 an opportunity cost? Considering that you can either rent the factory space and earn benefit or keep the equipment in it and product.
Also, What if the calculate required only year 0. In this case no matter what the discount factor the value would be 1.000.
What do you think imen!
Thanks for the reply.
The cost of capital cannot be calculated from the ROCE.
An exam question will always either give you the cost of capital or will give you enough information to be able to calculate the cost of equity, cost of debt, and therefore the WACC.
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