Ceder Ltd has details of two machines which could fulfill the company's future production plans. Only one of these machines will be purchased. The standard model costs...

Ceder Ltd has details of two machines which could fulfill the company's future production
plans. Only one of these machines will be purchased.
The standard model costs Sh.50,000, and the deluxe Sh.88,000, payable immediately. Both
machines would require the input of Sh.10,000 working capital throughout their working lives, and both
machines have no expected scrap value at the end of their expected working lives of four years for the
standard machine and six years for the deluxe machine.
The forecast pre-tax operating net cash flows associated with the two machines are:

The de-luxe machine has only recently been introduced to the market and has not been fully tested in
operating conditions. Because of the higher risk involved, the appropriate discount rate for the de-luxe
machine is believed to be 14% per year, 2% higher than the discount rate for the standard machine.
The company is proposing to finance the purchase of either machine with a term loan at a fixed interest
rate of 11% per year.
Taxation at 35% is payable on operating cash flows one year in arrears, and capital allowances are available
at 25% per year on a reducing balance basis.
You are required:
(a) to calculate for both the standard and the de-luxe machine:
(i) pay-back period;
(ii) net present value
Recommend, with reasons, which of the two machines Ceder Ltd should purchase.
(Relevant calculations must be shown)
(b) If Ceder Ltd were offered the opportunity to lease the standard model machine over a four year
period at a rental of Sh.15,000 per year, not including maintenance costs, evaluate whether the
company should lease or purchase the machine.

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Kavungya answered the question on April 22, 2021 at 13:48

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