Old MathJax webview

QUESTION ONE [50] Diamond Merchant Ltd produces crushed Diamond used in exclusive jewelled pieces across South Africa. The company operates 50 diamond crushing plants across the country and because of the nature of the business, accuracy in terms of weighting orders is essential. At present, at each plant, clerks prepare delivery notes for customers, weigh the product to be dispatched and record details of each delivery. Owing to the inefficiency and inaccuracy of the clerks, the company is considering replacing them with a computerised system at each plant. On average, the financial implications of this decision, per plant, at current prices are as follows: Note R'000 1400 Computerised equipment - initial outlay 1 Operating costs per annum: 1 600 Present labour-based method 1 500 Proposed computerised method 200 Transportation cash costs per annum: Associated with present system Associated with proposed system 100 Notes : 1. The estimate of R 1500 000 for the proposed computerised method includes straight- line depreciation of R300 000 calculated on the equipment's net cost. (Net cost= Initial outlay less proceeds on disposal at the end of the asset's four year life). The disposal proceeds have been estimated at current prices for the purposes of calculating net cost. There is no depreciation incurred using the present labour based method. 2. The cost of the computerised equipment, the disposal proceeds and operating costs are all expected to increase at the general rate of inflation of 8%. The transportation costs, however, are expected to inflate at a rate of 7% per annum. Income tax rates applicable to Diamond Merchant: 1. Tax is payable at the rate of 40% in the year incurred (i.e. it is not payable in arrears). 2. As an incentive to encourage investment, computerised equipment of this nature can be written off for tax purposes in equal instalments over three years. The annual depreciation allowance is based on the initial outlay at current prices and ignores the estimated disposal value. Any proceeds on disposal at the end of the asset's useful life are taxed at the normal rate of 40%. If the proposal is accepted, a loan, bearing interest at the nominal (i.e. money) rate of 10% per annum before tax, will be raised to finance the entire initial outlay. The company's nominal and real after tax cost of equity is 20% and 11,11% per annum respectively. The target debt equity ratio is 50:50 and the pooling of funds principle is adopted in determining the appropriate discount rate for evaluating capital investments. All cash flows, apart from the initial outlay which will occur immediately if the project is accepted, are assumed to take place at the end of each year