Compute   the payback period  and the Net present value of the proposal , using   Delta ‘s normal  current  cost of capital  and  five year life  and advise whether  Delta should  adopt  the new machine  giving its existing investment criteria.

Delta Telephone ltd. ,a subsidiary of a multinational  company is a supplier of telephone services to a medium sized community in Ghana. John Dela , the chief executive of the company has just attended a trade exhibition entitled ‘Automated Emigrate’ in Japan. As a result of what he learned  from  the exhibition  and information he has picked from  his peers in other companies , Mr Dela  is concerned about  Delta’s ability  to maintain its competitiveness position in the telecommunication market in Ghana. Owing to deregulation in the telecommunication industry and the aggressive action of new competitors in the local area, a significant number of Delta’s customers have switched to other suppliers of telephone and related telecommunication services. Mr Dela feels that if Delta were to invest fully in new state- of –the- art  fiber-optics  technology as well as upgrade in the   latest computer equipment , the loss of market share may be arrested  and operating efficiency may be improved . He contacted a leading vendor of fiber-optics system and associated computer equipment to obtain information on operating characteristics and costs.  This vendor would provide the necessary fiber-optics equipment, all associated installation costs, computer hardware and initial software support for a total cost of GHS30,000,000. Although powerful and flexible, the new equipment is also compact, requiring much less space than the existing equipment. In addition the equipment will require fewer people to operate and support it. Thus, additional benefits are realised by savings in occupancy and personal support costs. The new equipment promises to be highly reliable and easy to maintain and these attributes will lead to substantial savings in maintenance and repair costs. After Mr Dela  had consulted with his engineering and managerial accounting staff, the staff developed the following estimated annual cost of savings from implementing the new system.

The new equipment should also lead to reduced levels of working capital. Because of the vastly improved reliability of the new equipment, inventories of spares and repair equipment will be minimised and the high quality customer service will result in far fewer disputed customer accounts, so more customers will pay their bills on time. Mr Dela  expects a GHS 5,000,000 reduction in inventory and accounts receivables, which for simplicity of analysis occur in the first year of operating the new equipment.

In addition to the outlay costs for hardware and software, Dela  is aware that there are likely to be substantial in house expenses related to the installations of the new technology. The engineering and the accounting staff estimated GHS10,000,000 of one time internal costs for implementing the new technology. For internal reporting purposes, the GHS 10,000,000 internal costs will be capitalised along with the GHS 30,000,000 purchase price when determining the investment required for the new proposal. In addition, the GHS10,000,000 costs will be amortised over the useful life of the project. For simplicity, it may be assumed that the GHS 10,000,000 cost is required at the same time as the GHS 30,000,000 equipment purchase is made.

The vendor of the equipment requires an annual maintenance contract of GHS1,500,000 for the computer equipment and  the annual costs of maintaining and upgrading the software programme are assumed to be average about GHS 2,000,000.

The vendor is adamant that all the equipment will have at least 10 year useful life if it is properly maintained. The estimated disposal price of the equipment and software programme is GHS 5,000,000 at the end of five years and GHS 2,000,000 at the end of 10 years.  In evaluating capital expenditures  Delta uses  its current cost of capital and a maximum  time of horizon of five years. Delta Ltd is a listed company with 1 million ordinary shares of GH¢1 each currently valued at GH¢2. The company  beta at the stock exchange is estimated at 1.5 and the average return for stocks traded on the Ghana Stock Exchange estimated  to be 15% while the rate on Government of Ghana traded Treasury bills is 5%.. The Company is also financed with GHS1milliom debt capital with an after tax interest rate of 8%.

Mr Dela has marshalled all these data and wishes to evaluate the proposed investment in the new technology. Mr Dela  has approached your consulting firm  with all the above information to review the new equipment investment proposal and to advise on the possible purchase of  the equipment/

REQUIRED:

1. Compute   the payback period  and the Net present value of the proposal , using   Delta ‘s normal  current  cost of capital  and  five year life  and advise whether  Delta should  adopt  the new machine  giving its existing investment criteria.