Due to the strain on electricity demand in Gauteng during the cold winter months, Electrode (Ltd) an iron, steel and aluminium manufacturing company require a new generator costing R120 million. The company has the option to either lease or own the generator.

Cost of leasing: The lease would require annual end of year payments of R39.2 million over the four years. Service and insurance costs of R12.5 million per annum will be borne by the lessor. The lessee will exercise its option to purchase the asset for R15 million at the termination of the lease in four years.

Cost of owning: The cost could be financed with VB Finance Inc. It would require a four-year 16% loan, with annual year-end payments of R42.89 million. Electrode (Ltd) will pay maintenance cost of R9 million per annum. Depreciation charges are based on the straight-line method. At the end of the period the generator will be sold at its residual value of R20 million.

Interest payments included in the year-end payments are R19.2 million; R15.41 million; R10.02 million; and R5.92 million respectively.

The company is in the 30% tax bracket and the after-tax cost of the debt is 11%.

Required:

4.1 Determine the after-tax cash outflows and the net present value of the cash outflows under each alternative. Show all calculations. (22)

4.2 Which alternative would you recommend? Briefly explain. (3)