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MEDLOCK CONES & TUBES PLC  

James Taylor, the newly appointed financial analyst of the Steel Tube division of Medlock Cones & Tubes Plc, shut his office door and walked over to his desk. He had just 24 hours to re-examine the accountant's profit projections and come up with a recommendation on the proposed new computer numerically controlled (CNC) milling machine. 

At the meeting he had just left, the managing director made it quite clear: 'If the project can't pay for itself in the first three years, it's not worth bothering with.' James was unhappy with the accountant's analysis, which showed that the project was a loss maker. But as the MD said, 'Unless you can convince me by this time tomorrow that spending £240,000 on this capital project makes economic sense, you can forget the whole idea.' 

His first task was to re-examine the accountant’s profitability forecast (given below) in the light of the following facts that emerged from the meeting:  

1. Given the rapid developments in the market, it was unrealistic to assume that the product   had more than a four-year life. The machinery would have no other use and could not raise more than £20,000 in scrap metal at the end of the project.  

2. The opening stock in Year 1 would be acquired at the same time as the machine. All other stock movement would occur at the year-ends.   

3. This type of machine was depreciated over six years on a straight-line basis.  

4. Within the 'other production expenses' were apportioned fixed overheads equal to 20 percent of labour costs. As far as could be seen, none of these overheads were incurred as a result of the proposal.  

5. The administration charge was an apportionment of central fixed overheads  

 

 

 

 

 

 

 

 

 

 

Profit projection for CNC milling machine (£000) 

   

Year

1

2

3

4

Sales

400

600

800

600

Less Costs

     

 

     Materials

     

 

     Opening Stock

40

80

80

60

     Purchases

260

300

360

240

     Closing Stock

-80

-80

-60

-

Cost of Sales

220

300

380

300

     Labour

80

120

120

80

     Other production expenses

80

90

92

100

     Depreciation

40

40

40

40

     Administrative overhead

54

76

74

74

     Interest on loans to finance the project

22

22

22

22

Total Cost

496

648

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