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XYZ Co. is a listed company which plans to meet increased demand for its products

by buying new machinery costing $5 million. The machinery would last for four years,

at the end of which it would be replaced. The scrap value of the machinery is expected

to be 5% of the initial cost. Tax-allowable depreciation would be available on the cost

of the machinery on a 25% reducing balance basis, with a balancing allowance or

balancing charge claimed in the final year of operation.This investment will increase production capacity by 9,000 units per year and all of these units are expected to be sold as they are produced. Relevant financial information in current price terms is as follows:

Selling price	650 per unit	4.0%
Variable cost	250 per unit	5.5%
Incremental fixed costs	250,000	5.0%

In addition to the initial cost of the new machinery, initial investment in working capital

of $500,000 wili be required. Investment in working capital will be subject to the general

rate of inflation, which is expected to be 4,7% per year.

XYZ Co. pays tax on profits at the rate of 20% per year, one year in arrears. The

company has a nominal (money terms) after-tax cost of capital of 12% per year.

a) Calculate the net present value of the planned purchase of the new machinery

using a nominal (money terms) approach and comment on its financial acceptability.

15 marks]

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