Oseikrom Ventures is considering minimising its production cost through automation of its production system. Two machines are being considered to save cost. The estimated data for the two machines available on the market are as follows:

Required:
a) Using the following methods, which machine should be selected?
i) Net Present Value (8 marks)

ii) Discounted Payback Period (4 marks)

b) Identify and explain TWO (2) advantages of the Net Present Value technique. (3 marks)

Mawuena Ltd, a manufacturer of building materials has recently suffered falling demand due to economic recession, and thus has unutilised capacity. Management has identified an opportunity to produce designer ceramic tiles for the home improvement market. It has already paid GH¢1.5 million for development expenditure, market research and feasibility studies.

A new machine, with a useful life of four years could be bought at GH¢6.5million, payable immediately. The scrap value of the machine is expected to be 5% of the cost recoverable a year after the end of the project.

The research and development division has prepared the following demand forecast:
Year                                      1                  2                    3                    4
Demand (units)             110,000        130,000         150,000          145,000

The selling price is GH¢50 per box (at today’s price). Estimated operating costs, largely based on experience are as follows:

Cost per box of tiles (at today’s price)                                    GH¢
Materials cost                                                                             12.00
Direct labour                                                                               5.00
Variable overhead                                                                      2.50
Fixed overhead (allocated)                                                       3.50
Distribution (Variable)                                                              5.50

In addition to the initial cost of machinery, investment in working capital of GH¢0.2 million will be required in year two. Mawuena Ltd pays tax one year in arrears at an annual rate of 30% on returns from the project. Mawuena Ltd shareholders required a nominal return of 14% per annum after tax, which includes allowance for generally expected inflation of 5.55% per annum. (Ignore Capital Allowance).

Required:
Assess the financial desirability of this venture in real terms, computing the net present value offered by the project.                               (14 marks)

The Maintenance Manager of Prudence Ltd insists that management should maintain an old equipment that had been used for 5 years and is fully depreciated rather than buy a new one. The old equipment has a current operating cost of GH¢53,000.00 per annum. The operating cost of the equipment is expected to increase at 5% every year over the next four years, with a sale value of GH¢6,500.00 in the fifth year.

The Maintenance Manager has proposed, that a new system with enhanced technology to reduce operating cost to GH¢32,000.00 for the next three years and GH¢33,600.00 for the fourth and fifth years be introduced. The new equipment will cost GH¢60,000.00 and when introduced, a redundancy cost of GH¢25,000.00 will be paid, with the old equipment sold for GH¢12,000.00. The sale value of the new equipment will be GH¢10,200.00 after its five years’ useful life.

Required:
Using Net Present Value (NPV) method of capital appraisal with 20% cost of capital, advice management on which option Prudence Ltd should go for.                                                                                                                                             (10 marks)

Agyasco Ltd, a software company has developed a new game “Lando” which it plans to launch in the near future. Sales volumes, production volumes and selling prices for “Lando” over its four-year life are expected to be as follows:

Financial information on “Lando” for the first year of production is as follows:
Direct material cost GH¢5.4 per game
Other variable production cost GH¢6.00 per game
Fixed costs GH¢4.00 per game.

Advertising costs to simulate demand are expected to be GH¢650,000 in the first year of production and GH¢100,000 in the second year of production. No advertising costs are expected in the third and fourth years of production. Fixed costs represent incremental cash fixed production overheads. “Lando” will be produced on a new production machine costing GH¢800,000. Although this production machine is expected to have a useful life of up to 10 years, Government legislation allows Agyasco Ltd to claim the capital cost of the machine against the manufacture of a single product. Capital allowances will therefore be claimed on a straight-line basis over four years.

Agyasco Ltd pays tax on profit at a rate of 30% per annum and tax liabilities are settled in the year in which they arise. Agyasco Ltd uses an after-tax discount rate of 10% when appraising new capital investments. Ignore inflation.
Required:
Calculate the net present value of the proposed investment and comment on your findings.                                          (10 marks)