A. Joseph’s Engineering Ltd need to acquire new equipment and it can either take a loan or have a lease option. The loan funds of $100 000 at 8.2% p.a. after tax, compounded semi-annually for 2 years. The company has three directors in the business and they pay individual income tax at an average rate of 35%. Inland Revenue Department (Tax office) allows depreciation at the rate of 50% p.a. on this equipment. Advise the company which is the better deal, the loan or a 2 year lease with four equal payments of $26,674 starting with the first payment at the signing of the contract. Assume that corporate tax rate is 28% for simplicity’s sake the tax benefits from each lease payment and the tax benefits forgone for depreciation are received without time lag in each half-year period.
Required:
1. Prepare a cash flow. Which financing method is most suitable?
B. Pacific Energy Ltd outlet has a throughput of 180 000 litres of Unleaded fuel each week. Purchases are always made in multiples of 1000 litres. Holding costs including evaporation and variation in volumes due to temperature changes are estimated to be $10 per 1000 litres. Ordering costs are $1 per order.
Required:
1. What is EOQ, calculate on weekly data of Pacific Energy?
2. Given the circumstances above, do you believe Pacific Energy would keep strictly to the EOQ with each order it submits to its suppliers? Why or why not? If you calculated the EOQ on daily turnover data, what values must change to achieve the same EOQ as calculated on a weekly basis?
3. List some management techniques used by financial managers in Pacific Energy to assist in inventory management? [Hint: Pacific Energy’s inventory is the Fossil Fuel]
C. Fiji Golf Ltd has decided to sell a new line of golf clubs. The club will sell for $700 per set and have a variable cost of $340 per set. The company has spent $150,000 for a marketing study that determined the company will sell 46,000 sets per year for seven years. The marketing study also determined that the company will lose sales of 12,000 sets of its high-priced clubs. The high-priced clubs sell at $1100 and have variable costs of $550. The company will also increase sales of its cheap clubs by 20,000 sets. The cheap clubs will sell for $300 and have variable costs of $100 per set. The fixed costs each year will be $8,000,000. The company has also spent $1,000,000 on research and development for the new clubs. The plant and equipment required will cost $16,100,000 and will be depreciated on a straight line basis. The new clubs will also require an increase in net working capital of $900,000 and that will be returned at the end of the project. The tax rate is 30%, and the cost of capital is 14%.
Required:
Calculate the Payback Period and Net Present Value followed by recommendations.
