Page 4 of 34
FIN3701
CONFIDENTIAL
JANUARY/FEBRUARY 2022
QUESTION 1 [21 marks]
Merck 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.
Merck Ltd is considering the replacement of outdated equipment, which will allow the firm to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 result in the sales
revenue of R5 950 000 and total operational cost of R2 480 000 per annum before tax for
another four years, when the life of this product line is expected to end. The expected after-tax
proceeds from the sale of the new equipment amounts to R1 512 000 in four years’ time.
The current tax value of the present equipment is R300 000 and its current market value is
R410 000. 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. The marginal tax rate is 28%
and the firm has a cost of capital of 12%.
REQUIRED
1.1 Calculate the net present value (NPV), internal rate of return (IRR) and payback period
(Pb) for the replacement. (18 marks)
[TURN OVER]
, Page 9 of 34
FIN3701
CONFIDENTIAL
JANUARY/FEBRUARY 2022
1.2 State on the basis of the NPV, IRR and Pb whether the company should replace the
equipment.
NB: The maximum acceptable payback period for Merck Ltd is 2 years. (3 marks)
[TURN OVER]
FIN3701
CONFIDENTIAL
JANUARY/FEBRUARY 2022
QUESTION 1 [21 marks]
Merck 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.
Merck Ltd is considering the replacement of outdated equipment, which will allow the firm to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 result in the sales
revenue of R5 950 000 and total operational cost of R2 480 000 per annum before tax for
another four years, when the life of this product line is expected to end. The expected after-tax
proceeds from the sale of the new equipment amounts to R1 512 000 in four years’ time.
The current tax value of the present equipment is R300 000 and its current market value is
R410 000. 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. The marginal tax rate is 28%
and the firm has a cost of capital of 12%.
REQUIRED
1.1 Calculate the net present value (NPV), internal rate of return (IRR) and payback period
(Pb) for the replacement. (18 marks)
[TURN OVER]
, Page 9 of 34
FIN3701
CONFIDENTIAL
JANUARY/FEBRUARY 2022
1.2 State on the basis of the NPV, IRR and Pb whether the company should replace the
equipment.
NB: The maximum acceptable payback period for Merck Ltd is 2 years. (3 marks)
[TURN OVER]
