- 12 Marks
FM – L2 – Q64 – DCF: Specific applications
Evaluate whether to acquire a machine and recommend purchase or lease, considering NPV with tax and capital allowances.
Question
NexGen Enterprises is considering whether to acquire a new machine. The machine has a purchase cost of GH₵30,000, an expected useful life of five years, and a disposal value of GH₵6,000 at the end of year 5. The machine would generate additional cash flows of GH₵10,000 in each of its five years.
Two methods of financing are under consideration:
(i) To buy the machine with money obtained from a bank loan, at an interest rate of 8% after tax.
(ii) To lease the machine. The lease payments to the lessor would be GH₵7,000 at the end of each of the next five years.
The company’s cost of capital is 10% after tax.
Corporation tax is 30%. If the machine is purchased, the company will be able to claim capital allowances (tax depreciation allowances) of 25% each year on a reducing balance basis. Tax is payable at the end of the year following the year against profits earned during Year 1.
Required:
(a) Recommend whether the machine should be acquired.
(b) If your recommendation is to acquire the machine, recommend whether it should be purchased or leased.
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