The Directors of Geraldo Manufacturing Ltd. are considering whether to replace the companys equipment for the manufacture of Naphthalene balls.

Naphthalene balls are currently made on equipment which cost GH20,000 fourteen years ago. The equipments remaining useful life is estimated at 6 years and the net receipts from manufacturing Naphthalene balls can be assumed to continue at GH12,000 per year for that period. The net receipts comprise sales minus cost of production, but no deduction has been made for depreciation.

A leasing company has approached the firm with an offer of new equipment. The equipment would be leased to Geraldo Manufacturing Ltd. for GH9,000 per year, payable at the beginning of each year in which the equipment is leased. The leasing agreement would be effective for 6 years. The Directors estimate that the equipment would produce GH21,000 per year in net receipts (defined as above, but before lease payments).

The Team Leader of the Production Unit has also discovered that a new equipment identical to that offered by the Leasing Company can be purchased for GH37,000. The purchased equipment would have a useful life of 6 years with no scrap value. Annual net receipts would be the same as if the equipment were leased, except that GH1,000 per year would have to be spent on maintenance which in the leasing arrangement would be covered by the actual leasing charge.

If either Leasing or Purchase were undertaken the old equipment would be sold for GH2,000.

Assume the following In any sale or purchase of equipment the appropriate payment would be received or made immediately, and annual amounts would occur at the end of the appropriate years except where specifically stated to the contrary. Working Capital is provided by creditors and can therefore be ignored in the options open to the company. Geraldos cost of capital in all relevant years is 12% per annum.

REQUIRED An appraisal of the alternatives available to Geraldo Manufacturing Ltd. on the basis of the Net Present Value Model of Investment Appraisal (Capital Budgeting). Comment on the implications of your results, including reservations where necessary.

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