Cedar Ltd has details of two machines which fulfil the company’s future production plans. Only one of these machine will be purchased.

The “standard” model costs GHC 50,000 and the “ de-luxe” GHC 88,000 payable immediately. Both machines would require the input of GHC 10,000 working capital throughout their working  lives, and both machines have no expected scrap value at the end of their expected working lives of four years for the standard machine and six years for De-lux machine.

The forecast pre-tax operating cash flows associated with the two machines are:

The de-luxe machine has only recently been introduced to the market and has not been fully tested in operating conditions. Because of the higher risk involved, the appropriate discount rate for the de-luxe machine is believed to be 14% per year, 2% higher than the discount rate for the standard machine.
The company is proposing to finance the purchase of either machine with a term loan at a fixed interest rate 11% per year

Taxation at 35% is payable on operating cash flows one year in arrears, and capital allowances are available at 25% per year on a reducing balance basis.

You are required:
(a) To calculate for both the standard and de-luxe machine

I. Pay-back period

II. Net present value

Recommend with reasons, which of the two machines Cedar Limited should purchase (with relevant calculations)

(b) If Cedar Limited were offered the opportunity to lease the standard model machine over a four-year period at a rental of GHc 15,000 per year, not including maintenance costs, evaluate whether the company should lease or purchase the machine.

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Years Standard Machine De-Lux (Cash flow) GHC (cash flow) GHC 1. 20,500 32,030 22,860 26,110 24,210 25,380 4 23,410 25,940 38,580 6 35,100 2. 3. Years Standard Machine De-Lux (Cash flow) GHC (cash flow) GHC 1. 20,500 32,030 22,860 26,110 24,210 25,380 4 23,410 25,940 38,580 6 35,100 2. 3.