Becca, a fast food company is considering replacing its existing equipment, which is near the end of its useful life.
Details in relation to the investment are provided below:
1. Cost to purchase new equipment: $800,000.
2. Investment life: 5 years.
3. Expected production volume: 20,000 units per year. Each unit could be sold for $30.
4. Variable cost includes direct material $31 unit, direct labour cost $2/ unit and variable overhead $3/ unit.
5. Fixed overhead cost is $20,000I year.
6. $30,000 system updating cost is required in year 2 and year 4.
7. According to the depreciation guide from the Tax Office this equipment wifl be fully depreciated after 5 years (no residual value). However, Becca’s accountant believes it can be sold for $140,000 at the end of year 5.
8. The tax rate is 30%. Discount rate for the company is 11%.
Required:
1. Calculate NPV of the proposed investment.
2. What type of investment would this be classified as? Based on your calculation in Question 1, would you advise Becca invest in this project? Explain why or why not.
3. What are the limitations of NPV analysis?