QUESTION 1 CS Limited operates a chain of cafs that are located in third level colleges in Namibia. The managing director is evaluating an investment proposal regarding which type of coffee machine CS Limited will introduce into the cafs at the end of the expected useful life of the current coffee machine. The useful life of the current machine will expire within the next year. The managing director commissioned a report that would assist in deciding which one of the three new machines should be introduced into the caf in IUM University on a pilot basis. The cost of this report is n$65,000 which will be paid immediately. The managing director is of the view that whichever machine will be purchased the investment proposal would require a minimum payback period of two years and a positive NPV after three years. The company's cost of capital is 5%. There are three different types of machine under consideration - CM1, or CM2 or CM3. Each machine has an expected three-year useful life. Other information compiled to date includes projected product unit costs and projected contribution for each of the three machines. Machine CM1 The CM1 machine will cost N$240,000 with an estimated scrap value of N$30,000. Unit Costs for coffee drink with this machine - Per Product Unit Machine CM2 The CM2 machine will cost N$190,000 with an estimated scrap value of N$40,000. Unit Costs for coffee drink with this machine - Per Product Unit Direct Materials N$1.00 Direct Labour N$0.60 Prime Cost N\$1.60 Machine Maintenance Cost (variable cost) N$0.20 Contribution N$0.70 Year 1 Expected Revenue (based on forecast numbers) N$441,000 Year 1 Expected Contribution N$123,480 Year 1 Projected Maintenance Cost (variable cost) N$35,280 Machine CM3 The CM3 machine will cost N$140,000 with an estimated scrap value of N$50,000. Unit Costs for coffee drink with this machine - Per Product Unit Direct Materials N$1.00 Direct Labour N\$0.60 Prime Cost N\$1.60 Machine Maintenance Cost (variable cost) N$0.20 Contribution N$0.20 Year 1 Expected Revenue (based on forecast numbers) N$252,000 Year 1 Expected Contribution N$25,200 Year 1 Projected Maintenance Cost (variable cost) N$25,200 Other Information: For each machine the maintenance costs are expected to increase by 5% each year for the next two years. Other variable costs (direct materials and direct labour) are expected to stay constant. Customer numbers are expected to increase by 10% each year over the next two years. There is no projected change in the unit sales price. At the end of Year 2 for both Machine CM1 and Machine CM2, a royalty payment (once off fee) of N$50,000 has to be paid. There is no royalty payment for the CM3 machine. Marketing costs of N$30,000 must be paid up front for each machine. Revenue Projections (Based on market research). No of Customers in Munster University using caf: Opening Hours 08.0020.00 No of Patrons (Daily) 1,400 Monday - Saturday Percentage of customers that will buy coffee if CM1 is purchased 40% Percentage of customers that will buy coffee if CM2 is purchased 35% Percentage of customers that will buy coffee if CM3 is purchased 25% The working week is from Monday to Saturday. Every day on average there are 1,400 customers. The caf operates on the basis of 360 days per year. The existing CS machine that is currently being used was purchased at a cost of N$300,000 having a four-year life with zero scrap value. It still has N$75,000 depreciation remaining as it was bought three years ago. Due to the location of IUM University in a designated area, tax will not be payable on any profits arising from the introduction of any of the new coffee machines. REQUIREMENT: Prepare extracts from a Report to the Managing Director with the information presented in the following order: a) A Table showing the results of your calculations and initial recommendations based on (1) The Payback and (2) NPV methods. Note: Include any detailed workings on separate pages as an appendix to your report. Rounding is required to 2 decimal places. (15 marks)
