Read the information provided below on a capital acquisition planned by Lubners Limited and advise them whether to undertake the capital expenditure or not. INFORMATION: Lubners Limited operates transport division which offers long haul transport. It has a fleet of trucks which are replaced as the maintenance costs become excessive. One of the trucks needs replacing and Lubners Limited is considering the following purchase: 1 A Volvo F1350 which costs R1 500 000 for the horse and a further R500 000 for a custom made trailer. This truck will have a useful life of five years after which it will be sold for 10% of its total purchase cost. The first alternative is to use this purchase in normal operations in which customers are charged per kilometre transported and the expected net cash revenue in the first year is expected to be R460 000 and this is expected to increase by 10% every year. A second alternative is to use this purchase for a long term contract with an established client. This contract is for a period of five years with annual cash revenues of R580 000 for each of the five years. It is company policy to depreciate vehicles over its useful life on a straight line basis and the cost of capital used to evaluate capital projects is 12%. Internal rate of return is not used in evaluating capital projects

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 25P

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QUESTION 4 REQUIRED: Read the information provided below on a capital acquisition planned by Lubners Limited and advise them whether to undertake the capital expenditure or not. INFORMATION: Lubners Limited operates transport division which offers long haul transport. It has a fleet of trucks which are replaced as the maintenance costs become excessive. One of the trucks needs replacing and Lubners Limited is considering the following purchase: 1 A Volvo F1350 which costs R1 500 000 for the horse and a further R500 000 for a custom made trailer. This truck will have a useful life of five years after which it will be sold for 10% of its total purchase cost. The first alternative is to use this purchase in normal operations in which customers are charged per kilometre transported and the expected net cash revenue in the first year is expected to be R460 000 and this is expected to increase by 10% every year. A second alternative is to use this purchase for a long term contract with an established client. This contract is for a period of five years with annual cash revenues of R580 000 for each of the five years. It is company policy to depreciate vehicles over its useful life on a straight line basis and the cost of capital used to evaluate capital projects is 12%. Internal rate of return is not used in evaluating capital projects.

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