The new machine will incur fixed annual maintenance costs of $145,000 per year. Variable costs are expected to be $3·00 per unit and selling price is expected to be $5·65 per unit. These costs and selling price estimates are in current price terms and do not take account of general inflation, which is forecast to be 4·7% per year.
It is expected that the new machine will need replacing in four years’ time due to advances in technology. The resale value of the new machine is expected to be $200,000 at that time, in future value terms.
The purchase price of the new machine is payable at the start of the first year of the four-year life of the machine. Working capital investment of $150,000 will already exist at the start of the four-year period, due to the operation of the existing machine. This investment in working capital is expected to increase in nominal terms in line with the general rate of inflation.
Argnil Co pays corporation tax one year in arrears at an annual rate of 27% and can claim 25% reducing balance tax-allowable depreciation on the purchase price of the new machine. The company has a real after-tax weighted average cost of capital of 6% and a nominal after-tax weighted average cost of capital of 11%.
Required:
(a) Using a nominal terms net present value approach, evaluate whether purchasing the new machine is financially acceptable. (10 marks)
(b) Discuss the reasons why investment finance may be limited, even when a company has attractive investment opportunities available to it. (5 marks)