Gosling Wines $($Pty$)$ Ltd has been in the business of producing top quality wines since the early $2000$s$.$ It started off as a small family hobby, but soon grew to be a successful listed wine farm in the Pretoria East area. The business now produces wine with top quality equipment. Due to the increasing demand for wines, they have started with the process of building a new additional wine cellar on their farm. This project is planned to be finished by $31$ July $2024$ and will help the business to meet the high customer demand.

Gosling Wines is investigating the possibility of expanding into the production of exclusive fruit juices, specifically sparkling and non$-$sparkling juice through a new investment project.

The following draft information of a proposed investment project has been prepared for management by a trainee accountant.

Projected annual cash flows:

Year

$1$

R

$2$

R

$3$

R

$4$

R

Sales $($units$/$year$)$

$275000$

$440000$

$550000$

$275000$

Revenue

$3630000$

$6040320$

$7852416$

$4083256$

Variable costs

$(2117500)$

$(3489640)$

$(4492912)$

$(2313849)$

Fixed costs

$(551250)$

$(578813)$

$(607753)$

$(638141)$

Depreciation

$(400000)$

$(400000)$

$(400000)$

$(400000)$

Interest payments

$(220000)$

$(220000)$

$(220000)$

$(220000)$

Taxable profit

$341250$

$1351868$

$2131751$

$551266$

Taxation @ $27\%$

$(92138)$

$(365004)$

$(575573)$

$(138042)$

Profit after tax

$249113$

$986863$

$1556179$

$373224$

Scrap value

$(275000)$

After tax cash flows

$249113$

$986863$

$1556179$

$98224$

$12\%$ discount factor

$0,083$

$0,797$

$0,712$

$0,636$

Present values

$222422$

$786721$

$1107657$

$62423$

Net present value R$2179224$

Initial investment $($R$2000000)$

R$179224$

Conclusion: The net present value is positive and therefore management can accept the project.

MAC$3702$

MAY$/$JUNE $2024$

$[$CONFIDENTIAL$]$ Page $8$ of $15$

QUESTION $1($continued$)$

The following additional information was included with the draft investment appraisal:

Additional information

$1.$ The initial investment for the acquisition of the machinery in the project is R$2$ million.

$2.$ The selling price in current price terms $($therefore Year $0)$ is R$13,20$ per unit and it is expected that the price will increase at a rate of $4\%$ per annum.

$3.$ The variable cost in current price terms is R$7,48$ per unit and it is expected that the price will increase at a rate of $3\%$ per annum.

$4.$ The fixed overhead costs in current price terms are R$525000$ per year and it is expected that these costs will increase at a rate of $5\%$ per annum.

$5.$ Fixed costs include R$225000$ per year of development costs that have already been incurred and are being recovered by an annual charge to the project.

$6.$ The investment will be financed through a R$2$ million loan at a fixed interest rate of $12\%$ per year.

$7.$ Gosling Wines can claim $25\%$ capital allowances on the cost of investment and the current company tax rate is $27\%.$

$8.$ The value of the machinery required for the investment project at the end of the four$-$year period is R$275000.$

$9.$ The real weighted average cost of capital $($WACC$)$ of Gosling wines is $10\%.$

$10.$ The general rate of inflation is expected to be $4,9\%$ per year.

REQUIRED

$($a$)$

Recalculate the net present value of the proposed investment project and comment on the acceptability of the proposed project.

$[$Round your answers to the nearest Rand$]$

$(25)$

$($b$)$

Identify any errors in the proposed investment project prepared by the trainee accountant and comment on the errors, if any, you identified.

$(10)$

Total question $1$