Portfolio 1 Champion Co

Champion is considering the purchase of new equipment which will enable the company to expand its operations. The equipment will cost 1.2 million and have a three-year life; at the end of which it will have a scrap value of 600,000. The equipment will mean that Champion will require more factory space at an annual rental of 80,000; payable in advance, with the first payment being made on the day the equipment is purchased. Further annual fixed costs charged to the project will be 715,000 in total. This includes 86,000 of bank interest payable on the loan to cover the cost of the equipment. 74,000 of costs allocated out of head office overheads. A depreciation charge for the new machinery that has been calculated using the straightline method over the life of the machine.

Additional annual sales are expected to be 60,000 units per annum in each of the three years. Each unit will sell for 40 and has a variable production cost of 25. A further investment of 350,000 will be required for working capital. This will need to be in place at the start of the year. This amount will increase to 410,000 in the following year, and 460,000 in the year after that. This working capital investment will be fully recovered at the end of the project.

If Champion buys the new equipment, then it can claim capital allowances on the investment on a 25% reducing balance basis. The company pays taxes in the year to which it relates at an annual rate of 30%. Champion uses a cost of capital of 11% per annum for appraising its investments

Task

1) Discuss the implications of your findings to Champion.