Leeds Limited is looking to expand its operations and increase its market share in the cell phone industry. To achieve this,they are looking to increase its current productive capacity of 100 000 cell phones a year by at least 6% for each of thenext 5 years. It is considering two cell phone making machines and is unsure which to purchase:Cell Phone Machine ABC:Cell Phone Machine ABC can be imported at a landed purchase cost of R160 000 and a further R20 000 transport andinstallation costs will have to be incurred to get it ready for production. This machine is expected to last 5 years after whichit will be sold at its scrap value of R20 000. Net cash flow from the sale of the additional production is expected to beR58 000, R63 000, R68 000, R72 000 and R51 000 respectively over the 5-year lifespan of the machine. This machinewill enable Leeds Limited to achieve a 4% increase in productive capacity.Cell Phone Machine XYZ:Cell Phone Machine XYZ can be purchased locally for R190 000 and will also have a useful life of 5 years. It will not haveany resale value at the end of the 5 years and will be disposed of. Net cash inflows from additional production will amountto R62 000 per annum for each of the five years. This machine will enable Leeds Limited to achieve a 2% increase inproductive capacity.Additional information:• Leeds Limited requires a return on capital of 12% for all investments made. The depreciation policy is todepreciate all non- current assets on a straight-line basis. Assume that all cash flows occur at the end of eachfinancial year except for the initial investment which occurs in period 0.• The capital expenditure committee has indicated that R370 000 is available for this capital expenditure. In termsof the company’s capital expenditure policy, only projects with a payback period of less than four years areaccepted.REQUIREDYou are the financial manager at Leeds Limited and have been asked by the Board of Directors to advise them on whichmachine/s to authorise for purchase. Using appropriate capital budgeting techniques which must include the PaybackPeriod, Net Present Value and Accounting Rate of Return results to compile a report to the Board of Directors detailingthe option that should be chosen.
Leeds Limited is looking to expand its operations and increase its market share in the cell phone industry. To achieve this,
they are looking to increase its current productive capacity of 100 000 cell phones a year by at least 6% for each of the
next 5 years. It is considering two cell phone making machines and is unsure which to purchase:
Cell Phone Machine ABC:
Cell Phone Machine ABC can be imported at a landed purchase cost of R160 000 and a further R20 000 transport and
installation costs will have to be incurred to get it ready for production. This machine is expected to last 5 years after which
it will be sold at its scrap value of R20 000. Net cash flow from the sale of the additional production is expected to be
R58 000, R63 000, R68 000, R72 000 and R51 000 respectively over the 5-year lifespan of the machine. This machine
will enable Leeds Limited to achieve a 4% increase in productive capacity.
Cell Phone Machine XYZ:
Cell Phone Machine XYZ can be purchased locally for R190 000 and will also have a useful life of 5 years. It will not have
any resale value at the end of the 5 years and will be disposed of. Net
to R62 000 per annum for each of the five years. This machine will enable Leeds Limited to achieve a 2% increase in
productive capacity.
Additional information:
• Leeds Limited requires a return on capital of 12% for all investments made. The
depreciate all non- current assets on a straight-line basis. Assume that all cash flows occur at the end of each
financial year except for the initial investment which occurs in period 0.
• The capital expenditure committee has indicated that R370 000 is available for this capital expenditure. In terms
of the company’s capital expenditure policy, only projects with a payback period of less than four years are
accepted.
REQUIRED
You are the
machine/s to authorise for purchase. Using appropriate capital budgeting techniques which must include the Payback
Period,
the option that should be chosen.
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