QUESTION1: Fraser\'s Fruit Company (FFC) is considering the purchase of new refr
ID: 2807691 • Letter: Q
Question
QUESTION1: Fraser's Fruit Company (FFC) is considering the purchase of new refrigeration containers to be used for storage of fruits. If it goes through with the purchase, it will spend $400,000.00 on the containers and an additional $20,000.00 for installation and commissioning. The new containers will be used for five years, during which time they will be depreciated toward a $40,000.00 salvage value using straight-line depreciation. The new containers are expected to have a market value in five years' time that equals to its estimated salvage value. The new refrigeration containers will be used to replace FFC existing units, which are fully depreciated but can be sold for an estimated $20,000.00. The existing containers are usable for five more years, after which time they will have no salvage value. The existing containers consume $200,000.00 per year in electricity cost, whereas the new, more efficient containers are estimated to consume electricity cost of S150,000.00 per year. In addition, the new containers will be covered under warranty, so the maintenance cost per year is expected to be only S12,000.00 compared to $35,000.00 for the existing units. Investment in working capital is also expected to increase from the current $10,000.00 to S15,000.00 and fully recovered at the end of the project. If FFC requires a 15% discount rate in new investment, should the refrigeration containers be replaced? (Use the NPV and IRR criteria to decide)Explanation / Answer
Step 1) Initial investnment : Purchase of new container + installation expense+ WC requirement-Salvage value of old machine
=400000+20000+5000-20000
=405000$
Step 2) depreciation = Cost-salavage value/no of years
=420000-40000/5
=76000$
Step 3) Statement showing NPV
Since NPV is negative, New containers should not be purchased
Pariculars 1 2 3 4 5 Total Savings in electric cost 50000 50000 50000 50000 50000 Savings in maintenance cost 23000 23000 23000 23000 23000 Release of WC 5000 Salvage value of machine 40000 Total cash flow 73000 73000 73000 73000 118000 PVIF @ 15% 0.870 0.756 0.658 0.572 0.497 PV 63478 55198 47999 41738 58667 267080 Less: initial investment 405000 NPV -137920