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MSA Limited, a manufacturing company in South Africa, is intending to expand its output capacity by acquiring a new machine from South Korea in order to meet the expected increase in demand for energy saving globe. They are intending to utilise the machine in production for the next three years. The company has two options they can either lease or buy the machine. LEASE The company could lease the machine directly from the supplier for annual lease payments of R255 000, payable in arrears. The lease term is three years and the company will have the option to purchase the machinery on termination of the lease at a cost of R84 000. The financial manager intends to exercise the option. The lessee is responsible for the maintenance and insurance costs of the manufacturing equipment which is R2800 and R1100 per month respectively. BUY: The company could purchase the machine for R700 000 cash. The current total cost for insurance and maintenance combined is R75 000 per annum while the current running costs (water and electricity) for similar machines is R55 000 per annum. Maintenance and insurance is expected to increase from year 2 every year at the same rate of inflation which is expected to be 8% per annum. Due to improvements in the water supply and the use of renewable means of energy in the factory, running costs are expected to decrease at a rate of 5% per annum starting from year two. After the three-year period, MSA Limited will sell the machine for R150 000. Assume a tax rate of 30% applies and that the after-tax cost of debt is 11%

MSA Limited, a manufacturing company in South Africa, is intending to expand its output capacity by acquiring a new machine from South Korea in order to meet the expected increase in demand for energy saving globe. They are intending to utilise the machine in production for the next three years. The company has two options they can either lease or buy the machine. LEASE The company could lease the machine directly from the supplier for annual lease payments of R255 000, payable in arrears. The lease term is three years and the company will have the option to purchase the machinery on termination of the lease at a cost of R84 000. The financial manager intends to exercise the option. The lessee is responsible for the maintenance and insurance costs of the manufacturing equipment which is R2800 and R1100 per month respectively. BUY: The company could purchase the machine for R700 000 cash. The current total cost for insurance and maintenance combined is R75 000 per annum while the current running costs (water and electricity) for similar machines is R55 000 per annum. Maintenance and insurance is expected to increase from year 2 every year at the same rate of inflation which is expected to be 8% per annum. Due to improvements in the water supply and the use of renewable means of energy in the factory, running costs are expected to decrease at a rate of 5% per annum starting from year two. After the three-year period, MSA Limited will sell the machine for R150 000. Assume a tax rate of 30% applies and that the after-tax cost of debt is 11%

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
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1. Determine the after-tax cash flows and the net present value of the cash outflows under each alternative. (Show all calculations) 

2. Which alternative would you recommend? Why?

MSA Limited, a manufacturing company in South Africa, is intending to expand its output capacity by acquiring a new machine from South Korea in order to meet the expected increase in demand for energy saving globe. They are intending to utilise the machine in production for the next three years. The company has two options they can either lease or buy the machine. LEASE The company could lease the machine directly from the supplier for annual lease payments of R255 000, payable in arrears. The lease term is three years and the company will have the option to purchase the machinery on termination of the lease at a cost of R84 000. The financial manager intends to exercise the option. The lessee is responsible for the maintenance and insurance costs of the manufacturing equipment which is R2800 and R1100 per month respectively. BUY: The company could purchase the machine for R700 000 cash. The current total cost for insurance and maintenance combined is R75 000 per annum while the current running costs (water and electricity) for similar machines is R55 000 per annum. Maintenance and insurance is expected to increase from year 2 every year at the same rate of inflation which is expected to be 8% per annum. Due to improvements in the water supply and the use of renewable means of energy in the factory, running costs are expected to decrease at a rate of 5% per annum starting from year two. After the three-year period, MSA Limited will sell the machine for R150 000. Assume a tax rate of 30% applies and that the after-tax cost of debt is 11%
Transcribed Image Text:MSA Limited, a manufacturing company in South Africa, is intending to expand its output capacity by acquiring a new machine from South Korea in order to meet the expected increase in demand for energy saving globe. They are intending to utilise the machine in production for the next three years. The company has two options they can either lease or buy the machine. LEASE The company could lease the machine directly from the supplier for annual lease payments of R255 000, payable in arrears. The lease term is three years and the company will have the option to purchase the machinery on termination of the lease at a cost of R84 000. The financial manager intends to exercise the option. The lessee is responsible for the maintenance and insurance costs of the manufacturing equipment which is R2800 and R1100 per month respectively. BUY: The company could purchase the machine for R700 000 cash. The current total cost for insurance and maintenance combined is R75 000 per annum while the current running costs (water and electricity) for similar machines is R55 000 per annum. Maintenance and insurance is expected to increase from year 2 every year at the same rate of inflation which is expected to be 8% per annum. Due to improvements in the water supply and the use of renewable means of energy in the factory, running costs are expected to decrease at a rate of 5% per annum starting from year two. After the three-year period, MSA Limited will sell the machine for R150 000. Assume a tax rate of 30% applies and that the after-tax cost of debt is 11%
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