Please advise whether Lubners Limited can undertake the capital expenditure or not.

INFORMATION:

Lubners Limited operates transport division which offers long haul transport. It has a fleet of trucks which are

replaced as the maintenance costs become excessive. One of the trucks needs replacing and Lubners Limited is

considering the following purchase:

A Volvo F1350 which costs R1 500 000 for the horse and a further R500 000 for a custom made trailer. This truck

will have a useful life of five years after which it will be sold for 10% of its total purchase cost.

The first alternative is to use this purchase in normal operations in which customers are charged per kilometre

transported and the expected net cash revenue in the first year is expected to be R460 000 and this is expected

to increase by 10% every year.

A second alternative is to use this purchase for a long term contract with an established client. This contract is

for a period of five years with annual cash revenues of R580 000 for each of the five years.

It is company policy to depreciate vehicles over its useful life on a straight line basis and the cost of capital used

to evaluate capital projects is 12%. Internal rate of return is not used in evaluating capital projects.