Mtawarira Ltd is looking to increase its production capacity in order to meet the forecasted demand

for its product, rugby balls, which has seen an encouraging increase in demand and sales as a result

of the success of various South African teams in international tournaments. Quotes have been

received for the new machine, and management have established that the cost of the machine

would be R750 000 from its preferred supplier. Delivery costs are expected to be 10% of the

purchase cost and import duties are expected to amount to R55 000.

The new machine has an annual production capacity of 60 000 units and is expected to be used for

a period of three years, after which it is expected to be sold at its estimated scrap value of R185 000.

The existing machines have a production capacity of 75 000 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 UNITS

1 142 500

2 135 000

3 105 000

Management have estimated that, if the new product were to be sold to customers today, it would

have a current selling price of R50 per unit, and a variable cost of R40 per unit. Price inflation is

expected to be 5% per annum for sales and 3% per annum on variable costs. Fixed overheads are

anticipated to increase at 4% per annum each year from year two onwards. Fixed overheads are

expected to amount to R40 000 in the first year.

The manufacture and sale of the new product 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 2% of sales linked

to the production from the new machine for that year.

Additional information:

Mtawarira 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.

Mtawarira Ltd use their WACC (Weighted Average Cost of Capital) to appraise capital

investment projects. The current WACC of the company has been calculated as 14%.

Required:

(Round off all calculations to the nearest rand except for price calculations to be rounded to two

decimals)

Q.5.1 Calculate the working capital requirement for Mtawarira Ltd for the new machine. (13)

Q.5.2 Calculate the initial investment for the new machine. (5)

Q.5.3 Calculate the operating cash flow for Mtawarira Ltd that relates to the new

machines for year 13 only. (25)

Q.5.4 What type of capital expenditure (capex) will the acquisition of the new machine

be classified as? Provide a reason for your answer.