Reference no: EM133041029

Question - Trax Ltd is a manufacturer of high-quality plastic products made to demanding specifications, which makes replication of designs difficult. The company relies on marketing programmes to ensure that models are constantly changed, and that demand follows new designs. This allows the company to maintain margins in a highly competitive environment. Trax Ltd is considering the replacement of outdated equipment, which will allow the firm to manufacture a new line of products. The cost of the new equipment is R8,5 million and the company qualifies for a depreciation deduction of 40% of cost for the first year, and 20% in each of the subsequent three years. The equipment is also expected to reduce the cost of producing an existing product line by R180 000,00 per annum before tax for another four years, when the life of this product line is expected to end. The expected residual value of the equipment is R2,1 million in four years' time. The new line of products will result in a selling price of R85,00 per unit and variable cost of R38,00 per unit. The product line is expected to result in a constant demand of 70 000 units per annum for four years. The current tax value of the present equipment is R300 000,00 and its current market value is R410 000,00. The equipment is expected to have a residual value of zero in four years' time. The investment in net working capital will amount to R475 000,00. The marginal tax rate is 28% and the firm has a cost of capital of 12%.

1. Calculate the net present value (NPV), internal rate of return (IRR) and payback period (Pb) for the replacement.

1. State on the basis of the NPV, IRR and Pb whether the company should replace the equipment.