Reference no: EM132665732

Lota Ltd used discounted cash-flow techniques to evaluate capital expenditure projects. They are contemplating the acquisition of a machine at a cost of R234 000.The probabilities of its life expectancy are as follows:

10 years 0.2
11 years 0.5
12 years 0.3

• For a premium which will be payable in addition to the purchase price, the supplier of the machine is prepared to guarantee that the machine will last at least 11 years.
• The machine produces a single product with a selling price of R12 per unit and variable cost of production of R7 per unit.

The probabilities of the following production volumes are:

5 000 units per annum 0.1
6 000 units per annum 0.3
7 000 units per annum 0.6

The present value of R1 per annum at the company's screening rate for capital projects is as follows:

10 years R6.71
11 years R7.13
12 years R7.52

Required:

Problem a) Advise Lota Ltd on whether they should acquire the machine.

Problem b) Calculate how much Lota Ltd can afford to pay by way of a premium in the first year for a guarantee that the machine will last 11 years.