Depreciation is calculated using the straight-line method
Study the information given below and determine which of the two investment opportunities It should choose. Motivate your answer by comparing the net present value of each alternative.
INFORMATION
The management of Sentach Incorporated is considering two investment opportunities:
The first alternative involves the purchase of new equipment for R440 000 which will enable the company tomodernise its maintenance facility. The equipment Is expected to have a useful life of five years and a R22 000 salvage value. On the day Sentach Incorporated purchases the new equipment, it would also pay the equipment manufacturer R16 SOO for training costs to teach employees to operate the new equipment. The modernisation is expected to Increase efficiency, resulting in a R118 250 reduction in annual operating expenses.
The second alternative involves purchasing a truck. Purchasing another truck will enable the company to expand its delivery area and increase revenue. The truck costs R632 500. Its useful life is expected to be five years and a salvage value of R165 000 is anticipated. Operating the truck will necessitate an increase in Inventory of supplies, petty cash, and its accounts receivable and payable balances. These changes would add R27 500 to the company’s working capital base immediately upon buying the truck. The working capital cash outflow is expected to be recovered at the end of the truck’s useful life. The truck Is expected to generate R379 500 per year in additional revenues. The driver’s salary and other operating expenses are expected to be R176 000 per year. A major overhaul costing 8110000 is expected to be required at the end of the third year of operation.
Sentach Incorporated desires a rate of return of 14%.
REQUIRED
Calculate the accounting rate of return (on average investment) from the information provided below.
INFORMATION
Villa Limited is considering the purchase of Machine A, details of which are provided below:
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The cost of capital is 15%. Depreciation is calculated using the straight-line method.
