A year ago, Robin plc invested in a machine to improve the manufacturing of one of its products. It has just discovered that a new machine has come onto the market which would improve performance more than the one it bought. That machine cost € 8,000 a year ago, and is depreciated on a straight-line basis over 8 years (the same period as its useful life after which it will be scrapped). If it were sold now, the company would get around € 5,000 (tax credit on the capital loss would be 40%).
The new machine costs € 11,000 and would be depreciated for € 10,500 on a straightline basis over its useful life, estimated at 7 years. It could be sold at the end of its useful life for € 500 which is what its book value would be.
The company is hoping to produce 100,000 units of its product annually for the next 7 years. With the equipment currently in use, the company’s per-unit cost price breaks down as follows: € 0.14 per unit in direct labour costs, € 0.10 for raw materials and € 0.14 in general costs. The new machine will enable the company to cut direct labour costs to € 0.12 per unit produced. The cost of raw materials will drop to € 0.09 per unit thanks to a reduction in waste. General costs will remain € 0.14 per unit. All other factors will remain unchanged – in particular, supplies, energy consumed and maintenance costs. Profits are taxed at 40%.
(a) Draw up the cash flow schedule for the contemplated investment.
(b) Calculate the payback ratio on this investment.