Fire Ltd. (Fire) is a manufacturer and retailer of kitchen equipment and utilities. The entity has...
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Fire Ltd. ("Fire") is a manufacturer and retailer of kitchen equipment and utilities. The entity has a 31 October financial year-end and is located in Johannesburg. Traditionally, Fire imported the stoves that the entity sells. Management has however decided to rather invest in machinery to manufacture the stoves internally. The machinery required to manufacture the stoves - machine RRX2C - has a purchase price of R8 860 790. Fire does not currently have the sufficient cash flow available internally should the entity wish to proceed with the purchase of machine RRX2C. Fire can however borrow the funds at an 11.8% interest rate, compounded monthly to purchase machine RRX2C. The loan will be settled in 5 years' time and equal annual instalments will be made in arrears. A deposit of R780 000 will be paid on the loan. Machine RRX2C has an expected useful life of 5 years, whereafter it can be sold at a residual value of R10 800. Machine RRX2C will also qualify for a section 12C income tax deduction, whereby it will receive a 40% deduction in the first year and a 20% annual deduction thereafter. Should Fire decide to purchase RRX2C, the entity will extend their insurance contract to include machine RRX2C as a covered item. This will increase Fire's annual insurance payment from R4 110 000 (the current premium before machine RRX2C is purchased) to R4 934 000 (which will include the RRX2C machine as a covered item). The supplier of machine RRX2C also offers the option to customers of rather leasing the machine from them at a rate of R1 907 000 payable annually in advance. Irrespective of whether Fire decides on purchasing or leasing machine RRX2C, the entity (Fire) estimates that it will be selling 575 400 stoves annually at a price of R35 000 each. Fire's weighted average cost of capital is 12.89% and this includes a before-tax cost of debt of 12.5%. Assume the South African income tax rate applicable to companies is 28%. REQUIRED 1.1 1.2 1.3 Perform a net present value valuation of Fire Ltd.'s option to purchase machine RRX2C. (57 marks) Perform a net present value valuation of Fire Ltd.'s option to lease machine RRX2C for five years. Advise Fire Ltd. on which financing option the entity should pursue. (19 marks) (2 marks) Round to two decimal places where required and SHOW ALL CALCULATIONS. Fire Ltd. ("Fire") is a manufacturer and retailer of kitchen equipment and utilities. The entity has a 31 October financial year-end and is located in Johannesburg. Traditionally, Fire imported the stoves that the entity sells. Management has however decided to rather invest in machinery to manufacture the stoves internally. The machinery required to manufacture the stoves - machine RRX2C - has a purchase price of R8 860 790. Fire does not currently have the sufficient cash flow available internally should the entity wish to proceed with the purchase of machine RRX2C. Fire can however borrow the funds at an 11.8% interest rate, compounded monthly to purchase machine RRX2C. The loan will be settled in 5 years' time and equal annual instalments will be made in arrears. A deposit of R780 000 will be paid on the loan. Machine RRX2C has an expected useful life of 5 years, whereafter it can be sold at a residual value of R10 800. Machine RRX2C will also qualify for a section 12C income tax deduction, whereby it will receive a 40% deduction in the first year and a 20% annual deduction thereafter. Should Fire decide to purchase RRX2C, the entity will extend their insurance contract to include machine RRX2C as a covered item. This will increase Fire's annual insurance payment from R4 110 000 (the current premium before machine RRX2C is purchased) to R4 934 000 (which will include the RRX2C machine as a covered item). The supplier of machine RRX2C also offers the option to customers of rather leasing the machine from them at a rate of R1 907 000 payable annually in advance. Irrespective of whether Fire decides on purchasing or leasing machine RRX2C, the entity (Fire) estimates that it will be selling 575 400 stoves annually at a price of R35 000 each. Fire's weighted average cost of capital is 12.89% and this includes a before-tax cost of debt of 12.5%. Assume the South African income tax rate applicable to companies is 28%. REQUIRED 1.1 1.2 1.3 Perform a net present value valuation of Fire Ltd.'s option to purchase machine RRX2C. (57 marks) Perform a net present value valuation of Fire Ltd.'s option to lease machine RRX2C for five years. Advise Fire Ltd. on which financing option the entity should pursue. (19 marks) (2 marks) Round to two decimal places where required and SHOW ALL CALCULATIONS.
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Answer rating: 100% (QA)
11 PV of purchase option PV 1 907 000 575 40011289135 000 1 907 000 ... View the full answer
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