Ride Up Ltd. (“Ride Up”) is an outdoor sports and other gear manufacturer located in Johannesburg CBD. The entity’s financial yearend is 28 February. Although Ride Up has always purchased tents which they buy from an overseas supplier, the machinery required to produce high-quality tents has recently been made available to the South African market at affordable prices. Consequently, Ride Up is considering purchasing the required machine (Machine 10XP) on 1 March 2021, to manufacture the tents themselves The supplier of Machine 10XP is selling the machine for R 5 080 000. Alternatively, the machine can be leased from them at R770 000 payable annually in arrears. This is to allow the manufacturers to generate the required funds from sales of the tents during the year before being required to make the payment. Should Ride Up purchase the machine, they will qualify for a section 12C Income tax deduction of 40% in the first year and 20% thereafter. Ride Up will however not be able to finance the purchasing of Machine 10XP from their current funds and will take out a 4 year bank loan which will be payable in equal annual instalments in advance at an interest rate of 6.2% compounded quarterly. Additionally, Ride Up will purchase a maintenance contract of R91 000 annually, should they purchase the machinery. Machine 10XP has an expected useful life of 5 years whereafter it could be sold at a scrap value of R430 000. Irrespective of whether Ride Up purchase or lease Machine 10XP, it is estimated that Ride Up will sell 789 000 bicycles annually at R46 000 each. Ride Up has a weighted average cost of capital of 13.6% which includes a before-tax cost of debt of 11.7%. Assume an income tax rate of 28%. Required: 1.1 Perform a net present value valuation on Ride Up Ltd.’s option to purchase machine 10XP with the bank loan. 1.2 Perform a net present value valuation on Ride Up Ltd.’s option to lease ma-chine 10XP.
Ride Up Ltd. (“Ride Up”) is an outdoor sports and other gear manufacturer located in Johannesburg CBD. The entity’s financial yearend is 28 February. Although Ride Up has always purchased tents which they buy from an overseas supplier, the machinery required to produce high-quality tents has recently been made available to the South African market at affordable prices. Consequently, Ride Up is considering purchasing the required machine (Machine 10XP) on 1 March 2021, to manufacture the tents themselves The supplier of Machine 10XP is selling the machine for R 5 080 000. Alternatively, the machine can be leased from them at R770 000 payable annually in arrears. This is to allow the manufacturers to generate the required funds from sales of the tents during the year before being required to make the payment. Should Ride Up purchase the machine, they will qualify for a section 12C Income tax deduction of 40% in the first year and 20% thereafter. Ride Up will however not be able to finance the purchasing of Machine 10XP from their current funds and will take out a 4 year bank loan which will be payable in equal annual instalments in advance at an interest rate of 6.2% compounded quarterly. Additionally, Ride Up will purchase a maintenance contract of R91 000 annually, should they purchase the machinery. Machine 10XP has an expected useful life of 5 years whereafter it could be sold at a scrap value of R430 000. Irrespective of whether Ride Up purchase or lease Machine 10XP, it is estimated that Ride Up will sell 789 000 bicycles annually at R46 000 each. Ride Up has a weighted average cost of capital of 13.6% which includes a before-tax cost of debt of 11.7%. Assume an income tax rate of 28%. Required:
1.1 Perform a
1.2 Perform a net present value valuation on Ride Up Ltd.’s option to lease ma-chine 10XP.
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