The management of Diversified Products Limited (DPL) are investigating whether to increase plant capacity.

DPL is a manufacturing company that produces an array of products. One of its products, the Pod, has a selling price of R80 per unit.

Based on a market survey, which cost R68 500, the marketing director is convinced that sales will increase for the next five years if the company was to increase current capacity.

The marketing manager believes that capacity will increase to 35 000 should DPL buy a new plant. If DPL leased a new plant, there would be extra efficiencies and the capacity would increase to 40 000.

The marketing manager will earn a bonus of R90 000 at the end of year three if his estimations are correct. The companys current capacity is 30 000 units per annum. Each unit has a variable cost of R40 and an allocated fixed cost of R15, based on a capacity of 30 000 units per annum.

A new plant could be purchased for R850 000. The new plant has an estimated useful life of five years, at the end of which the salvage value is expected to be R230 000. It is estimated that because of technological advances, the new plant will result in increased efficiencies and a reduction in variable costs of R10 per unit. Fixed costs, other than depreciation, are expected to increase by R5 per unit.

The wear and tear allowance for the new machine is the same as the accounting depreciation. The lease payments would be R220 000, payable annually in advance for five years.

The companys WACC is 15%, the cost of equity 18% and the debt-to-equity ratio is 0.6. The companys tax rate is 28% and taxation is paid annually at the end of the year.

Required: Advise management in a letter as to whether they should buy or lease the new plant