Investing in sustainable energy has become increasingly important over the last couple of decades. Layer-by-Layer Ltd. (LbL), an entity with a 30 June-financial yearend, specialises in building sustainable energy plants.

LbL has received two requests to build sustainable energy plants one for a solar plant in the Northern Cape and the other for a wind plant in the Western Cape.

Unfortunately, LbL does not have enough internal resources to accept both projects. The projects are, therefore, mutually exclusive.

The solar energy plant will be built from 1 July 2023 to 30 June 2026 and LbL will be paid R93 million for the project, which LbL will receive in equal instalments at the beginning of each year. The wind energy plant will be built from 1 July 2023 to 30 June 2025 and LbL will receive 35% of the R85 million remuneration at the beginning of the project so that the entity has sufficient funds available to commence with the project. The remaining 65% will be paid once the project has been completed.

LbL performed a cost analysis breakdown of both energy plants for each year:

	Solar energy plant	Wind energy plant
Specialised direct materials	R7 820 000 NOTE 1	R3 140 000 NOTE 2
General direct materials	R3 525 000	R0
Direct labour	NOTE 3	NOTE 3
Overheads	NOTE 4	NOTE 4
Total cost	?	?

Note 1

R1 231 000 worth of the specialised materials were purchased and paid for 8 months ago by LbL. LbL will be using them in the solar energy plant, should LbL decide to accept the project. In this case, these purchased materials are expected to be fully utilised during the first year after erecting the solar energy plant and, thereafter, LbL will be required to purchase any further specialised materials required afresh.

Should LbL decide not to accept the solar energy plant project, LbL will not be able to resell these currently purchased materials to another party due to these materials specialised nature. LbL will, however, be able to utilise these materials in future projects.

Note 2

R2 860 000 of the specialised materials required for a wind energy plant was also purchased and paid for 8 months ago and should LbL decide on the wind energy plant, LbL will fully utilise them in the first year after erecting the wind energy plant. Thereafter, LbL will have to further purchase any specialised materials required.

However, should LbL not use these materials in the wind energy plant, LbL will be able to resell them. They have a net realisable value of R2 500 000 and a current purchase price of R3 100 000 at the supplier. LbL will not be utilising these materials in any future project.

Note 3

The solar energy plant will require 149 000 labour hours for which the labourers will be paid R48 per hour, while the wind energy plant will require 143 000 labour hours for which the labourers will be paid R36 per hour. LbL will ensure that the wages are kept in line with any inflationary changes so that the labourers can maintain their living standards. However, in order to prevent any labour unrest, LbL has made the decision not to decrease any wage rates once a rate has been previously given to the labourer.

Note 4

The overheads of each project amount to 37% of the total direct costs of the relevant project. The overheads can be broken down into the following composition: 85% fixed salaries, depreciation and administrative overheads, and 15% overheads which vary in direct proportion to the direct costs.

The fixed salaries are in regard to specialised employees, such as permanently appointed engineers of LbL. LbL has to pay their monthly salaries irrespective of which project is accepted if any.

The relevant property, plant and equipments current book value is R46 400 000. The items are depreciated over 20 years on the straight-line basis and were purchased and incorporated in the operations 8 financial years ago. The property, plant and equipment items qualify for an income tax allowance of 5% per year.

Should a property, plant and equipment item not be utilised in a project, the depreciation becomes a period cost for both accounting and taxation purposes.

Other information

The following is an extract of LbLs Statement of Financial Position for the financial year ending 30 June 2022:

Equity and Liabilities	R
Ordinary share capital	?
11.8% Preference share capital	?
11.22% Debentures	80 000 000
Deferred tax	300 000

LbL has correctly calculated the following pre-taxation cost of capitals: 13% for ordinary shares, 11.5% for preference shares and 11.22% for debentures.

Projects are funded from the pool of funds available within the entity and a specific source of finance is not assigned to a specific project. The composition of the pool of funds is not expected to change in the near future. LbLs ordinary shares are currently trading at R24 per share and the entitys preference shares at R26 per share. There are 3.5 million ordinary shares in issue and 2 million preference shares.

The current South African inflation rate is 6.5%, which is expected to increase to 7.5% in LbLs 2025 financial year. Thereafter, the South African inflation rate will stabilise at 7% during LbLs 2026-financial year onwards. Besides the respective remunerations of LbL for the project, all prices are presented as current prices.

A South African Income Tax rate for companies of 27% is expected for years of assessment which commence on or after 31 March 2021.

LbL has various projects and therefore, an income tax loss of one project is utilisable against another projects taxable income.

The various projects of LbL qualify as LbLs inventory according to the Income Tax Act specifically sections 22 (2A) and 22 (3A). You may assume that the Income Tax Act states the following in this regard:

o Any costs which are incurred for the project may only be deducted once the relevant project has been completed.

o Any income from a project is assumed to have accrued once becoming payable.

It may be assumed that today is 1 July 2023.

REQUIRED:

Advise LbL Ltd. whether the entity must accept the solar energy plant project, the wind energy plant project or neither.

Seperately for each project, make use of the Net Present Value, Internal Rate of Return and Equivalent Annual Annuities methods to substantiate your answer.

Financial considerations (calculations) - 82 marks

Discussion - 3 mark