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BAC221 Business Finance

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“Bull at a Gate Fabrications Pty Ltd” is a manufacturing business based in Sydney. Their company tax rate is 30%. It is considering the replacement of a manually operated machine with a fully automated model. Currently 6 full-time operators are needed to operate the machine. This labour costs the company

$320,000 p.a. in wages, holiday pay and compulsory superannuation payments to the employees’ selected funds. In addition, maintenance costs are $32,000 per year.

The machine was bought 4 years ago for $200,000. The Australian Tax Office schedule includes the asset in the 12 year useful-life category and only allows prime cost depreciation (with no residual) for this type of plant and equipment. The company believed that the machine normally would be taken out of service at the 12-year point.

The current disposal value of the machine presently in use is $50,000. The new model has a purchase price of $570,000. It is estimated that shipping and installation would cost $30,000. Maintenance on the new machine would be $60,000 p.a. but the adoption of that machine would cut the cost of defects from $20,000 to $4,000 per year.  

The new machine is in an 8 year useful life tax category (with no residual). As the machine will undergo heavy use, the company believes the 8 years may be quite accurate.  

The company expects the manufacturing business will close down after 8 years of operation of the new machine and that the machine will have no re-sale value at that point.  

The required rate of return for projects of this risk level is 10%.


  • Determine the cash flows associated with this replacement project.

  • Compute the NPV and advise if you would recommend the project. Included in your summing-up of the project you should make a comment on the IRR value of the project and why the IRR would have to be more or less than required rate of return


  • You are evaluating two different audio systems. Ear Surroundcosts $45,000, has a three-year life and costs $5 000 per year to operate. The Audio-Aura costs $65,000, has a five-year life, and costs $4,000 per year to operate. The relevant discount rate is 8 per cent and corresponds with an 8% before–tax cost of debt, with project totally debt-financed. Ignoring depreciation and taxes compute the AEC for both systems. Which one would be preferred if we assume zero salvage value at the end of life for both systems?
  • Now assume that prime cost (reflecting their respective lives) is used for both audio systems for tax depreciation purposes. The relevant tax rate is 30 per cent and tax is paid in the year of income. Assume that salvage value for both systems is $10,000. The relevant discount rate however drops to 5.6 per cent [8% * (1-30%)]. Compute the AEC for both systems. Which is preferred now?
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