Question

1. Weka Company Ltd has been considering the criteria that must be met before a capital expenditure proposal can be included in the capital expenditure programme. The screening criteria established by management are as follows:

1. No project should involve a net commitment of funds for more than four years.
2. Accepted proposals must offer a time adjusted or discounted rate of return at least equal to the estimated cost of capital. Present estimates are that cost of capital is 15 percent per annum after tax.
3. Accepted proposals should average over the lifetime, an unadjusted rate of return on assets employed (calculated in the conventional accounting method) at least equal to the average rate of return on total assets shown by the statutory financial statements included in the annual report of the company.

A proposal to purchase a new lathe machine is to be subjected to these initial screening processes. The machine will cost Sh2,200,000 and has an estimated useful life of five year at the end of which the disposal value will be zero.

Sales revenue to be generated by the new machine is estimated as follows:

YEAR	REVENUE (Shs. 000)
1	1,320
2	1,440
3	1,560
4	1,600
5	1,500

Additional operating costs are estimated to be Shs700,000 per annum. Tax rates may be assumed to be 30% payable in the year in which revenue is received for taxation purpose the machine is to be written off at a fixed annual rate of 20% on cost.

The financial accounting statement issued by the company in recent years show that profits after tax have averaged 18% on total assets.

Required

Present a report which will indicate to management whether or not the proposal to purchase the lathe machine meets each of the selection criteria.

Answer 1