Question
Kolisi Ltd, a local rugby balls manufacturer is looking to scale its production capacity in order to meet the forecasted demand for its balls which
Kolisi Ltd, a local rugby balls manufacturer is looking to scale its production capacity in order to meet the forecasted demand for its balls which has seen an encouraging increase in demand and sales as a result of Springboks winning the Webb Ellis Cup in 2019. Management have established that the cost of the machine would be $180 000 (Spot rate of $1 trading at R18.75) from its preferred US based supplier. Freight costs are expected to be 8.5% of the purchase cost and import duties are expected to amount to $5 000. The new state of the art machine has an an estimated useful life of 3 years. The existing machine initially cost R1 500 000 two years ago, and has an estimated useful life of four years. If the existing machine were to be sold today, it would be sold for a net selling price of R250 000. If the existing machine were to be retained until the end of its useful life, it would have a R nil resale value. The new state of the art machine has an annual production capacity of 80 000 units and is expected to be used for a period of three years, after which it is expected to be scrapped at R400 000. The existing machine have a production capacity of 95 000 units, so any excess demand will be met by the output of the new machine only. Management have provided you with the following demand and production of rugby balls over the next three years: Year Rugby Balls 1 162 500 2 185 000 3 125 000 2 Management have estimated that, if the new rugby balls were to be sold to customers today, it would have a current selling price of R65 per ball, and a variable cost of R45 per ball. Price inflation is expected to be 6.9% per annum for sales and 4.5% per annum on variable costs. Operating expenses are anticipated to escalate at 6% per annum each year from year one onwards. Operating expenses are expected to amount to R95 000 in the first year. The manufacture and sale of the new rugby balls will give rise to an additional working capital requirement. Management have indicated that, based on the historic trends of the company, the working capital requirement at the start of each year will equate to approximately 3.5% of sales linked to the production from the new machine for that year. Additional information: Kolisi Ltd currently pays corporation tax one year in arrears. The current corporation tax rate is 28%. Ignore VAT. SARS currently permits a S12C capital allowance on new qualifying fixed asset additions over a fouryear period at 40%/20%/20%/20%. A capital gains tax inclusion rate of 80% applies. Kolisi Ltd use their WACC (Weighted Average Cost of Capital) to appraise capital investment projects. The current WACC of the company has been calculated as 13%. Required: (Round off all calculations to the nearest to two decimals)
Q.1.3 Calculate the operating cash flows for Kolisi Ltd that relates to the new machines being purchased.
Q.1.4 Calculate the terminal cash flows
Q.1.5 Calculate total incremental operating cash flows (5)
Q.1.6 Calculate the Net Present Value (NPV) for Kolisi Ltd and advise the board whether they should replace the machine based on this appraisal method by providing a reason for your answer.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started