VW Limited, a South African-based chocolate manufacturing company, intends to expand its output capacity in order to meet the expected increase in demand from the industry. The company plan is to acquire a new machine from China. They have the option to either lease or purchase the new machinery. The machinery has a cost of R1 850 000.LEASE:The company can lease the machinery under a three-year lease. They have to make a payment of R600 000 at the end of each year. VW Limited has the option to buy the machinery at the end of the lease for R185 000 and the financial manager intends on exercising this option. Insurance costs of R14 000 are borne by the lessee.BUY: Alternatively, the company could finance the R1 850 000 cost of the machinery through its retained earnings, payable upfront. VW Limited will also pay an additional R52 000 per year for insurance costs while the current running costs (water and electricity) for similar machines are R55 000 per annum.Insurance is expected to increase by 6% per annum starting from year two. 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 11% per annum starting from year two.Depreciation is calculated using the straight-line method.Assume that the current corporate tax rate is 30% and the after-tax cost of debt is 11%.Required:You are required to: Determine the after-tax cash flows and the net present value of the cash outflows under each alternative.

FINANCIAL ACCOUNTING

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

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VW Limited, a South African-based chocolate manufacturing company, intends to expand its output capacity in order to meet the expected increase in demand from the industry. The company plan is to acquire a new machine from China. They have the option to either lease or purchase the new machinery. The machinery has a cost of R1 850 000.
LEASE:
The company can lease the machinery under a three-year lease. They have to make a payment of R600 000 at the end of each year. VW Limited has the option to buy the machinery at the end of the lease for R185 000 and the financial manager intends on exercising this option. Insurance costs of R14 000 are borne by the lessee.
BUY: Alternatively, the company could finance the R1 850 000 cost of the machinery through its retained earnings, payable upfront. VW Limited will also pay an additional R52 000 per year for insurance costs while the current running costs (water and electricity) for similar machines are R55 000 per annum.
Insurance is expected to increase by 6% per annum starting from year two. 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 11% per annum starting from year two.
Depreciation is calculated using the straight-line method.
Assume that the current corporate tax rate is 30% and the after-tax cost of debt is 11%.
Required:
You are required to: Determine the after-tax cash flows and the net present value of the cash outflows under each alternative.