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Ferris Industries is planning to replace its old equipment.

The old equipment cost was $350 000 five years ago. The old equipment is fully depreciated.

If the new equipment is purchased, arrangements will be made to sell the old equipment. The old equipment is expected to be sold for only $20 000 on 1 January 2021.

The new equipment will be placed in service on 1 January 2021. The details regarding the proposal are as follows:

• Expected acquisition cost $290 000
• Expected installation $20 000
• Expected investment allowance in year 1: 15%
• Estimated useful life: 7 years
• Expected salvage value which can be realised upon its disposal at the end of 7 years $30 000

Expected increase in sales due to the special production run of the new equipment

Year 1 to year 7 4000 units each year

• The selling price per unit expected to remain at $300
• The variable cost per unit is expected to be $250
• Expected increase in annual fixed costs due to the special production run of the new equipment is $62 000.

It is assumed that all cash flows occur at the end of each year.

The taxation depreciation on the equipment would be 25%per annum using the straight line method.

The company is subject to a 40% tax rate

The company uses a 12% after-tax discount rate.

Required:

1. Calculate the incremental profit (before tax) for each year due to the expected increase in sales.
2. Calculate the incremental after-tax cash flows for each year for Ferris Industries proposal to acquire the new equipment. (hint: prepare table of before and after tax annual cash flows, discount factor, present value of annual cash flows)
3. Should Ferris Industries invest in new equipment? Answer on basis of your calculations. Calculate and interpret the following for the proposed investment, the after tax

1. Net present value
2. Internal rate of return (hint: use goal seek function in excel or trial and error method)
3. Payback periods

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