Delta Telephone ltd. ,a subsidiary of a multinational company is a supplier of telephone services to a medium sized community in Ghana. John Dela , the chief executive of the company has just attended a trade exhibition entitled ‘Automated Emigrate’ in Japan. As a result of what he learned from the exhibition and information he has picked from his peers in other companies , Mr Dela is concerned about Delta’s ability to maintain its competitiveness position in the telecommunication market in Ghana. Owing to deregulation in the telecommunication industry and the aggressive action of new competitors in the local area, a significant number of Delta’s customers have switched to other suppliers of telephone and related telecommunication services. Mr Dela feels that if Delta were to invest fully in new state- of –the- art fiber-optics technology as well as upgrade in the latest computer equipment , the loss of market share may be arrested and operating efficiency may be improved . He contacted a leading vendor of fiber-optics system and associated computer equipment to obtain information on operating characteristics and costs. This vendor would provide the necessary fiber-optics equipment, all associated installation costs, computer hardware and initial software support for a total cost of GHS30,000,000. Although powerful and flexible, the new equipment is also compact, requiring much less space than the existing equipment. In addition the equipment will require fewer people to operate and support it. Thus, additional benefits are realised by savings in occupancy and personal support costs. The new equipment promises to be highly reliable and easy to maintain and these attributes will lead to substantial savings in maintenance and repair costs. After Mr Dela had consulted with his engineering and managerial accounting staff, the staff developed the following estimated annual cost of savings from implementing the new system.

Reduction in occupancy costs due to reduced floor space

GHS 2.0M

Lower maintenance and repairs

GH S4.0M

Reduced labour costs , fringe ,benefits and associated cost

GHS 7.0M

The new equipment should also lead to reduced levels of working capital. Because of the vastly improved reliability of the new equipment, inventories of spares and repair equipment will be minimised and the high quality customer service will result in far fewer disputed customer accounts, so more customers will pay their bills on time. Mr Dela expects a GHS 5,000,000 reduction in inventory and accounts receivables, which for simplicity of analysis occur in the first year of operating the new equipment.

In addition to the outlay costs for hardware and software, Dela is aware that there are likely to be substantial in house expenses related to the installations of the new technology. The engineering and the accounting staff estimated GHS10,000,000 of one time internal costs for implementing the new technology. For internal reporting purposes, the GHS 10,000,000 internal costs will be capitalised along with the GHS 30,000,000 purchase price when determining the investment required for the new proposal. In addition, the GHS10,000,000 costs will be amortised over the useful life of the project. For simplicity, it may be assumed that the GHS 10,000,000 cost is required at the same time as the GHS 30,000,000 equipment purchase is made.

The vendor of the equipment requires an annual maintenance contract of GHS1,500,000 for the computer equipment and the annual costs of maintaining and upgrading the software programme are assumed to be average about GHS 2,000,000.

The vendor is adamant that all the equipment will have at least 10 year useful life if it is properly maintained. The estimated disposal price of the equipment and software programme is GHS 5,000,000 at the end of five years and GHS 2,000,000 at the end of 10 years. In evaluating capital expenditures Delta uses its current cost of capital and a maximum time of horizon of five years. Delta Ltd is a listed company with 1 million ordinary shares of GH¢1 each currently valued at GH¢2. The company beta at the stock exchange is estimated at 1.5 and the average return for stocks traded on the Ghana Stock Exchange estimated to be 15% while the rate on Government of Ghana traded Treasury bills is 5%.. The Company is also financed with GHS1milliom debt capital with an after tax interest rate of 8%.

Mr Dela has marshalled all these data and wishes to evaluate the proposed investment in the new technology. Mr Dela has approached your consulting firm with all the above information to review the new equipment investment proposal and to advise on the possible purchase of the equipment/

REQUIRED:

Compute the payback period and the Net present value of the proposal , using Delta ‘s normal current cost of capital and five year life and advise whether Delta should adopt the new machine giving its existing investment criteria.

Question

Delta Telephone ltd. ,a subsidiary of a multinational company is a supplier of telephone services to a medium sized community in Ghana. John Dela , the chief executive of the company has just attended a trade exhibition entitled ‘Automated Emigrate’ in Japan. As a result of what he learned from the exhibition and information he has picked from his peers in other companies , Mr Dela is concerned about Delta’s ability to maintain its competitiveness position in the telecommunication market in Ghana. Owing to deregulation in the telecommunication industry and the aggressive action of new competitors in the local area, a significant number of Delta’s customers have switched to other suppliers of telephone and related telecommunication services. Mr Dela feels that if Delta were to invest fully in new state- of –the- art fiber-optics technology as well as upgrade in the latest computer equipment , the loss of market share may be arrested and operating efficiency may be improved . He contacted a leading vendor of fiber-optics system and associated computer equipment to obtain information on operating characteristics and costs. This vendor would provide the necessary fiber-optics equipment, all associated installation costs, computer hardware and initial software support for a total cost of GHS30,000,000. Although powerful and flexible, the new equipment is also compact, requiring much less space than the existing equipment. In addition the equipment will require fewer people to operate and support it. Thus, additional benefits are realised by savings in occupancy and personal support costs. The new equipment promises to be highly reliable and easy to maintain and these attributes will lead to substantial savings in maintenance and repair costs. After Mr Dela had consulted with his engineering and managerial accounting staff, the staff developed the following estimated annual cost of savings from implementing the new system.

Reduction in occupancy costs due to reduced floor space	GHS 2.0M
Lower maintenance and repairs	GH S4.0M
Reduced labour costs , fringe ,benefits and associated cost	GHS 7.0M

The new equipment should also lead to reduced levels of working capital. Because of the vastly improved reliability of the new equipment, inventories of spares and repair equipment will be minimised and the high quality customer service will result in far fewer disputed customer accounts, so more customers will pay their bills on time. Mr Dela expects a GHS 5,000,000 reduction in inventory and accounts receivables, which for simplicity of analysis occur in the first year of operating the new equipment.

In addition to the outlay costs for hardware and software, Dela is aware that there are likely to be substantial in house expenses related to the installations of the new technology. The engineering and the accounting staff estimated GHS10,000,000 of one time internal costs for implementing the new technology. For internal reporting purposes, the GHS 10,000,000 internal costs will be capitalised along with the GHS 30,000,000 purchase price when determining the investment required for the new proposal. In addition, the GHS10,000,000 costs will be amortised over the useful life of the project. For simplicity, it may be assumed that the GHS 10,000,000 cost is required at the same time as the GHS 30,000,000 equipment purchase is made.

The vendor of the equipment requires an annual maintenance contract of GHS1,500,000 for the computer equipment and the annual costs of maintaining and upgrading the software programme are assumed to be average about GHS 2,000,000.

The vendor is adamant that all the equipment will have at least 10 year useful life if it is properly maintained. The estimated disposal price of the equipment and software programme is GHS 5,000,000 at the end of five years and GHS 2,000,000 at the end of 10 years. In evaluating capital expenditures Delta uses its current cost of capital and a maximum time of horizon of five years. Delta Ltd is a listed company with 1 million ordinary shares of GH¢1 each currently valued at GH¢2. The company beta at the stock exchange is estimated at 1.5 and the average return for stocks traded on the Ghana Stock Exchange estimated to be 15% while the rate on Government of Ghana traded Treasury bills is 5%.. The Company is also financed with GHS1milliom debt capital with an after tax interest rate of 8%.

Mr Dela has marshalled all these data and wishes to evaluate the proposed investment in the new technology. Mr Dela has approached your consulting firm with all the above information to review the new equipment investment proposal and to advise on the possible purchase of the equipment/

REQUIRED:

Compute the payback period and the Net present value of the proposal , using Delta ‘s normal current cost of capital and five year life and advise whether Delta should adopt the new machine giving its existing investment criteria.

Accepted Answer

payback period is 2.22 year.

Initial Investment=30,000,000
Implementation cost=10,000,000
Payback…