investment appraisal
Investment Appraisal: The Gamma plc case Gamma plc is considering buying a new machine to expand their production of office furniture. The machine costs £1.3 million and will last for 5 years. The scrap value of these machines is £150,000. It is expected that the asset will be sold for this value on the last day of the fifth year, and that a replacement machine will then be purchased. An investment of £120,000 in working capital will be needed initially. The projected financial data are reported below.
Projected financial data (£) Year 1 Year 2 Year 3 Year 4 Year 5
Sales 1,100,000 1,380,000 1,450,000 1,450,000 1,350,000
Materials and components (280,000) (300,000) (380,000) (380,000) (300,000)
Labour (470,000) (490,000) (550,000) (550,000) (490,000)
Advertising (50,000) (50,000) (50,000) (50,000) (50,000)
Depreciation (170,000) (170,000) (170,000) (170,000) (170,000)
Allocated overheads (230,000) (230,000) (230,000) (230,000) (230,000)
Annual profit (100,000) 140,000 70,000 70,000 110,000 The following information is also available: 1. The machine would be financed with a 4-year bank loan at an interest rate of 11.5%, and would be bought on the last day of the company’s previous financial year. 2. The expenditure on materials and components, and labour is directly related to the project and would be avoided should this not be undertaken. 3. Advertising costs are paid yearly. 4. The overheads are a fair allocation of the production costs that will be incurred if the new machine is purchased. 5. The cost of capital for this type of investment is 10 per cent. The directors set a target accounting rate of return on investment
Projected financial data (£) Year 1 Year 2 Year 3 Year 4 Year 5
Sales 1,100,000 1,380,000 1,450,000 1,450,000 1,350,000
Materials and components (280,000) (300,000) (380,000) (380,000) (300,000)
Labour (470,000) (490,000) (550,000) (550,000) (490,000)
Advertising (50,000) (50,000) (50,000) (50,000) (50,000)
Depreciation (170,000) (170,000) (170,000) (170,000) (170,000)
Allocated overheads (230,000) (230,000) (230,000) (230,000) (230,000)
Annual profit (100,000) 140,000 70,000 70,000 110,000 The following information is also available: 1. The machine would be financed with a 4-year bank loan at an interest rate of 11.5%, and would be bought on the last day of the company’s previous financial year. 2. The expenditure on materials and components, and labour is directly related to the project and would be avoided should this not be undertaken. 3. Advertising costs are paid yearly. 4. The overheads are a fair allocation of the production costs that will be incurred if the new machine is purchased. 5. The cost of capital for this type of investment is 10 per cent. The directors set a target accounting rate of return on investment