Propfix Ltd. is planning a major upgrade of their plant at a cost of $75,000. The original plant was commissioned three years ago at a cost of $100,000. The location of the premises is critical to Propfix Ltd’s operation and is leased for $30,000 pa., paid at the start of each year. The landlord has given notice that the lease will terminate in exactly five years, and a payment of $50,000 to Propfix at this time to compensate them for the cost of improvements to the property was agreed to in the original lease terms. The plant will be scrapped as worthless.
The upgrade would permit Propfix to recondition 2000 propellers per year, an increase on the current 1500 per year, whilst at the same time reducing costs. The net revenue per propeller would therefore increase from the current $30 to $40 with the upgrade.
All capital items, including the cost of the upgrade, can be depreciated for tax purposes over 10 years straight line. The tax rate is 30%, and 70% of franking credits are claimed by shareholders. Propfix requires a return of 15% pa after tax on its investments. Should they make the upgrade?
The question belongs to Finance and it discusses about whether or not a company reconditioning propellers should make an upgrade.
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