Cedar Ltd has details of two machines which fulfil the company’s future production plans. Only one of these machine will be purchased. The “standard “model costs $50,000 and the “de-luxe” $88,000 payable immediately. Both machines would require the input of $10,000 working capital throughout their working lives. The forecast pre-tax operating cash flows associated with the two machines are: Years Standard Machine (cash flow) De-Lux (Cash flow) 1 20500 32030 2 22860 26410 3 24210 25380 4 23410 25940 5 0 38580 6 0 35100 Because of the higher risk involved, the appropriate discount rate for the de-luxe machine is believed to be 14% per year, 2% higher than the discount rate for the standard machine. The company is proposing to finance the purchase of either machine with a term loan at a fixed interest rate 11% per year. Taxation at 35% is payable on operating cash flows one year in arrears, and capital allowances are available at 25% per year on a reducing balance basis. You are required: (a) To calculate for both the standard and de-luxe machine pay- back period and the net present value and recommend with reasons, which of the two machines Cedar Limited should purchase (with relevant calculations) (b) If Cedar Limited were offered the opportunity to lease the standard model machine over four-year period at a rental of $15,000 per year, not including maintenance costs, evaluate whether the company should lease or purchase the machine.
Cedar Ltd has details of two machines which fulfil the company’s future production plans. Only one of these machine will be purchased.
The “
The
|
Years |
|
|
||
|
1 |
20500 |
32030 |
||
|
2 |
22860 |
26410 |
||
|
3 |
24210 |
25380 |
||
|
4 |
23410 |
25940 |
||
|
5 |
0 |
38580 |
||
|
6 |
0 |
35100 |
Because of the higher risk involved, the appropriate discount rate for the de-luxe machine is believed to be 14% per year, 2% higher than the discount rate for the standard machine.
The company is proposing to finance the purchase of either machine with a term loan at a fixed interest rate 11% per year.
You are required:
(a) To calculate for both the standard and de-luxe machine pay- back period and the
(b) If Cedar Limited were offered the opportunity to lease the standard model machine over four-year period at a rental of $15,000 per year, not including maintenance costs, evaluate whether the company should lease or purchase the machine.
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