The directors of EMY plc are currently considering an investment in a new production machinery to replace an existing one. The new machinery would produce goods more efficiently, leading to increased sales volume. The investment required will be GH¢1,150,000 payable at the start of the project.
The alternative course of action would be to continue using the existing machinery for a further five years, at the end of which time it would have to be replaced.
The following forecasts of sales and production volumes have been made:
S
ales in units
Year
|
Using existing machinery
|
Using new machinery
|
|
GH¢
|
GH¢
|
1
|
400,000
|
560,000
|
2
|
450,000
|
630,000
|
3
|
500,000
|
700,000
|
4
|
600,000
|
840,000
|
5
|
750,000
|
1,050,000
|
Production in units
Year
|
Using existing machinery
|
Using new machinery
|
|
GH¢
|
GH¢
|
1
|
420,000
|
564,000
|
2
|
435,000
|
637,000
|
3
|
505,000
|
695,000
|
4
|
610,000
|
840,000
|
5
|
730,000
|
1,044,000
|
Further information
1) The new machinery will reduce production costs from their present level of GH¢7.50 per unit to GH¢6.20 per unit. These production costs exclude depreciation.
2) The increased sales volume will be achieved by reducing unit selling prices from their present level of GH¢10.00 per unit to GH¢8.50 per unit.
3) The new machinery will have a scrap value of GH¢150,000 after five years.
4) The existing machinery will have a scrap value of GH¢30,000 at the start of Year 1.
Its scrap value will be GH¢20,000 at the end of Year 5.
5) The cost of capital to the company is 12% per annum.
Required
1. Prepare a report to the directors of EMY plc on the proposed investment decision.
2. List any further matters which the directors should consider before making their decision.