The production line would be set up in an unused space at the company’s main plant. The plant space could be leased out to another firm for $25,000 per year. They have to buy new machinery to fit the production and will disposal the old machine. The approximate cost of the new machine would be $200,000, with another $10,000 in shipping and handling charges. It would also cost an additional $30,000 to install the equipment. The new machinery has an economic life of 5 years and would fall under Class 8 with a CCA rate of 20%. It is expected to have a salvage value of $25,000 after 5 years of use.
The old machine was purchased 2 years ago before the project with $150,000, plus $30,000 installation fees. It has an economic life of 5 years and would fall under Class 5 with a CCA rate of 15%.
Currently the old machine is producing sales of 1,500 units per year in its economic life and the sales are expected to grow 5% per year. The variable cost per unit that the old machine produced is estimated as $75 per unit in the first year. Each unit can be sold for $150 in the first year. The net operating working capital would have to increase by an amount equal to 10% of sales revenues. The company has signed a contract to sell the old machine with $80,000 to accommodate the new machine.
The new product line would generate sales of 2,000 units per year for 5 years and they are expected to grow 8% per year. The variable cost per unit is estimated in $80 per unit in the first year. Each unit can be sold for $200 in the first year.
The fixed costs are estimated to be $100,000 per year and would increase with inflation. To handle the new product line, the firm’s net operating working capital would have to increase by an amount equal to 15% of sales revenues. The firm tax rate is 35%, and its overall weighted average cost of capital (WACC) is 10%. The project is considered by the financial department to be as risky as the company. However, the sales division addressed their concern that the new project will affect the existing another textile by $200,000 per year, The financial division has estimated that sales price and cost are both expected to increase by 2.5% per year due to inflation.