Lion Plastics $($Pty$)$ Ltd is a manufacturer of high quality outdoor products, manufactured from

recycled plastic. The company is currently considering the purchase of cutting equipment, which will

allow the company to produce a new range of garden furniture.

The cost of the new equipment is R$3\mathrm{.}5$ million and SARS will allow a deduction from taxable income

of $40\%$ of the cost in the first year and $20\%$ per annum thereafter. The equipment will be depreciated

for accounting purposes over its useful life of $5$ years to its expected residual value of $R800000.$

Budgeted annual demand for the new garden furniture $($which is sold in a set consisting of one table

and four chairs$)$ over the useful life of the equipment is expected to be as follows:

It is expected that the new garden set will sell at a price of R $15000$ per set. The cost of recycled

plastic, manual labour and other variable costs per garden set are estimated to amount to R$10000.$

The company's fixed costs are expected to increase by R$950000$ per annum which relates to

maintenance of the new equipment well as depreciation.

An investment in working capital would be required when the new equipment is purchased to the

value of R$450000.$

Lion Plastics $($Pty$)$ Ltd has sufficient taxable income available from other product lines to set off

against any tax losses created by the investment in the new range of garden furniture.

If the investment is undertaken, sufficient funding could be obtained through a loan from the bank

which has been negotiated bearing interest at $10\%$ per annum. Alternatively the company can issue

ordinary shares at the current market value. Lion Plastics $($Pty$)$ Ltd has a weighted average cost of

capital of $18\%.$

Mr Forest, the managing director of Lion Plastics $($Pty$)$ Ltd was overheard saying the following to a

colleague at a recent board meeting:

$"$We should absolutely go ahead with the investment in new cutting equipment to produce the

new range of garden furniture. The project has a payback period of less than $3$ years! I do not

understand the hesitation of some of the board members."

You may ignore the impact of inflation.Prepare a net present value $($NPV$)$ analysis for the investment in new sanding and cutting equipment and advise Lion Plastics $($Pty$)$ Ltd whether they should produce the new range of garden furniture. You are to assume, unless otherwise stated, that cash flows occur at the end of every year.