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A unit of Product T will be sold for GH¢ 12.00 and the variable cost of production is expected to…

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A unit of Product T will be sold for GH¢ 12.00 and the variable cost of production is expected to be GH¢ 7.50 per unit. Incremental annual fixed production overheads of GH¢ 25 million per year will be incurred. Selling price and costs are all in current price terms but would increase as follows:

Selling price of Product T: 3% per year

Variable cost of production: 4% per year

Fixed production overheads: 6% per year

Other information

Nestle Gh. has a real cost of capital of 6% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year.

Nestle Gh. has a target return on capital employed of 20%. Depreciation is charged on a straight-line basis over the life of the asset.

Required

a. Calculate the NPV of buying the new machine and comment of your findings (work to the nearest million).

b. Calculate the before – tax return on capital employed (ARR) based on the average investment and comment on your findings.

c. Discuss the strengths and weaknesses of IRR in appraising capital investments.

A unit of Product T will be sold for GH¢ 12.00 and the variable cost of production is expected to be GH¢ 7.50 per unit. Incremental annual fixed production overheads of GH¢ 25 million per year will be incurred. Selling price and costs are all in current price terms but would increase as follows:

Selling price of Product T: 3% per year

Variable cost of production: 4% per year

Fixed production overheads: 6% per year

Other information

Nestle Gh. has a real cost of capital of 6% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year.

Nestle Gh. has a target return on capital employed of 20%. Depreciation is charged on a straight-line basis over the life of the asset.

Required

a. Calculate the NPV of buying the new machine and comment of your findings (work to the nearest million).

b. Calculate the before – tax return on capital employed (ARR) based on the average investment and comment on your findings.

c. Discuss the strengths and weaknesses of IRR in appraising capital investments.

A unit of Product T will be sold for GH¢ 12.00 and the variable cost of production is expected to be GH¢ 7.50 per unit. Incremental annual fixed production overheads of GH¢ 25 million per year will be incurred. Selling price and costs are all in current price terms but would increase as follows:

Selling price of Product T: 3% per year

Variable cost of production: 4% per year

Fixed production overheads: 6% per year

Other information

Nestle Gh. has a real cost of capital of 6% and pays tax at an annual rate of 30% one year in arrears. It can claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year.

Nestle Gh. has a target return on capital employed of 20%. Depreciation is charged on a straight-line basis over the life of the asset.

Required

a. Calculate the NPV of buying the new machine and comment of your findings (work to the nearest million).

b. Calculate the before – tax return on capital employed (ARR) based on the average investment and comment on your findings.

c. Discuss the strengths and weaknesses of IRR in appraising capital investments.

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