Financial management revision question and answer

BCB Company is a manufacturer of bricks and concrete blocks. The company is considering replacing part of the current manual labour force purchasing a small tractor with a forklift for use in loading bricks and concrete blocks. The purchase price would be Sh.570,000. The tractor will have an economic life of 5 years but would require a Sh.20,000 overhaul at the end of 3 years. After 5 years the tractor could be sold for Sh.110,000.

The company estimates it will cost Sh.250,000 per year to operate the tractor. It will, however, save Sh.130,000 annually on labour cost. Because of increase in handling efficiency, losses caused breakages will be cut Sh.220,000 per year. Sales will also go up Sh.450,000. The new sales level is expected to be maintained throughout the tractor‟s life. Assume the company‟s gross margin ratio is 40%, corporate tax rate 30%, and cost of capital 16%. Also assume straight-line method of depreciation.

Required:
Determine the NPV of the project and state whether the tractor should be purchased.

Identify 3 circumstances under which NPV and IRR will give conflicting results for mutually exclusive projects.
ANSWER
Initial capital

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