QUESTION $1(47$ marks$)$

Convert Ltd $($Convert$)$ is a software developing entity listed in the technological sector

of the Johannesburg Stock Exchange $($JSE$).$

Convert develops various software programs $$ all with the intention to streamline and

assist entities$$ customers in achieving higher efficiencies in their respective

businesses.

Possible upgraded infrastructure

There is a current possibility to upgrade a portion of Convert$$s internal infrastructure

at R$17640000$ and sell off the previous infrastructure. This section of the

infrastructure is responsible for the development and production of one of Convert$$s

software programs called $$Game Changer$.$

Game Changer is in high demand amongst customers and all Game Changers

produced each year are sold out. Game Changer packages $($referred to as a $$unit$)$

are sold to customers for R$26000$ each and Convert$$s current infrastructure has the

ability to produce $290$ Game Changer packages per year.

Convert obtained the services of external industrial engineers to determine some of

the consequences of proceeding with the upgrade in the infrastructure.

Their feedback report to Convert indicated that although the variable cost of producing

each Game Changer unit will decrease from R$10200$ to R$9978,$ the allocated fixed

costs $($which currently includes depreciation of R$535000$ per annum$)$ will remain

unchanged at R$9100$ per unit. The infrastructure$$s useful life is also not expected to

be affected by the upgrade and will remain useful for four more years at which point

the upgraded infrastructure will be sold off for a scrap value of R$14300.$ While the

current infrastructure only qualifies for a $20\%$ wear$-$and$-$tear deduction per annum

according to section $12$C of the Income Tax Act, the new infrastructure will qualify for

a wear$-$and$-$tear deduction of $40\%$ of the cost in the first year and $20\%$ of the cost in

each of the remaining years thereafter. This cause the current infrastructure$$s wearand$-$tear deduction to be of the same value as the accounting depreciation each year.

$3$ HFMN$230-1-$Jan$-$June$2024-$SuppSA$1-$V$3-$ES$-09102023$

Financing alternative $1$: Loan

Convert has the option of obtaining a loan from Greenwich Bank to finance the

upgraded infrastructure$$s purchase.

Greenwich Bank has indicated that it will provide such a loan to Convert under the

loan terms of $10\mathrm{.}2\%$ quarterly compounding interest rate applicable and equal

instalments being paid annually in arrears over four years.

Financing alternative $2$: Lease

There is also an option available to rather lease the upgraded infrastructure from

Provider Ltd$.$ over the four$-$year period for R$3900000$ per annum payable annually in

advance.

Additional information:

$$ Convert$$s weighted average cost of capital is $11\mathrm{.}26\%.$

$$ Assume that the interest rate according to the Greenwich Bank loan is reflective

of Convert$$s general cost of debt after tax.

$$ The South African Income Tax rate applicable to companies is $27\%.$

REQUIRED:

$1\mathrm{.}1.$ Assist Convert Ltd by calculating the Net Present Value of the current

infrastructure.

$(21$ marks$)$

$1\mathrm{.}2.$ Advise Convert Ltd whether the entity should finance the upgraded

infrastructure by entering into a loan or lease agreement. Support the advice by

determining the Net Present Cost of both financing options separately.

$(26$ marks