Ilham plc is an electronic manufacturing company that is contemplating to increase production capacity by purchasing new machinery at an initial cost of RM2.5 million. The investment is expected to increase annual sales by 10,000 units. Investment in replacement machinery would be needed after five years. Financial data on the additional units to be sold is as follows:
Selling price per unit
Production costs per unit
RM
500
225
Variable administration and distribution expenses are expected to increase by RM800,000 per year as a result of the increase in capacity. In addition to the initial investment in new machinery, RM 500,000 would need to be invested in working capital. 25% of the working capital is expected to be recovered in year four, while the remaining will be recovered in the final year of the investment. The full amount of the initial investment in new machinery of RM5 million will give rise to capital allowances on a 25% per year reducing balance basis. The scrap value of the machinery after five years is expected to be negligible. Tax liabilities are paid in the year which they arise and Ilham ple pays tax at 30% of annual profits. Ilham ple uses an after tax discount rate of 12 per cent to evaluate investment proposals.
As an alternative to the above purchase option, the project managers of Ilham ple can also lease the machinery from a lessor.
Required:
a. Evaluate the proposed investment using the net present value and advise Ilham plc whether or not to proceed with the investment.
(15 marks)
b. Calculate the internal rate of return of the proposed investment and provide recommendation to the company.
(4 marks)
c. Explain the advantages and disadvantages of leasing the machinery rather than purchasing it.
(6 marks)
(Total: 25 marks)
