Question 4 Investment decisions Top Manufacturers Ltd (TM) currently uses Diesel machines in its manufacturing process. The company is contemplating the replacement of these machines on 1 June 2022, the first day of the new financial year, with new and more advanced Gas machines. The present annual production is 4 800 000 completed units (after spoilage has been discarded) which are sold at N$2,50 each. The Gas machines are capable of doubling this output. Sales above the present volume will, however, necessitate an all-round reduction in price from N$2,50 to N$2,00 per unit. There is uncertainty about exactly how many additional units can be sold, but a study made of the potential market resulted in an estimate of 4 200 000 additional units. The Diesel machines were purchased four years ago, on 1 June 2018, at a total cost of N$4 000 000. They are depreciated based on the straight-line method over an eight-year lifetime after deducting a scrap value of 10% of the cost. The scrap value is also the expected market value of the machines at the end of eight years. The unexpired life of these machines has now been estimated to be four years and the present market value is 30% of the original cost. The Gas machines will cost N$10 000 000, have an estimated life of four years, and a scrap value of 20% of the cost after four years. The present cost of production with the Diesel machines is as follows: Raw materials: N$1000 per 2 000 units put into the process. Spoiled units average 20% per annum and are of no value. Labour: 60% of the prime cost (raw materials plus labour) Factory overhead (excluding depreciation) : Allocated at the rate of 20% of direct labour cost Sundry administrative expenses amount to N$2 000 000 per annum. If the Gas machines are purchased, costs will change as follows: Raw materials: Reduction of 10% in prices due to quantity discount. Spoiled units will be less by half. Labour: 55% of the prime cost (raw materials plus labour) Factory overhead (excluding depreciation) : Allocated at a rate of 20% of direct labour cost Sundry administrative expenses will remain unchanged. Additional information When the Diesel machines were purchased, Namibia Revenue Authority (NAMRA) allowed a deduction of 50% of the cost in the first year, 30% of the cost in the second year, and 20% of the cost in the third year. The new machine will receive a 100% deduction in the year that the asset is brought into use. The current tax rate is 28%, and you are to assume that all cash flows, including tax payable, take place at the end of the year they are received or incurred. You may also assume that the company has other taxable income. The company desires a minimum return of 20% per annum after tax on all capital projects.

Required: Write a report to management, recommending whether the company should continue with the existing machine, replace the machine with the new one or discontinue production altogether. Your report should be supported with relevant calculations.