Question

QUESTION ONE a) Daniel Sawmill Ltd (DSL) produces and exports lumber and planks. It owns a plant which has a book value of GH¢1,800,000 as at 1 January 2014. The Government of Ghana passed a legislation that restricts the exportation of lumber. Consequently, DSL has to reduce production significantly. Cash flow forecast for the next four years included in the budget submitted for management approval in January 2014 shows the following: Year Cash Flows (GHC) 2014 550.00 2015 500.000 2016 300.000 2017 700,000 The cash flow forecast for 2017 includes expected proceeds from disposal of the plant. The cash flow projections also ignore the effects of general upwards movement in prices. It is estimated that if the plant is sold in January 2014, it would realize a net proceeds of GH¢1,320,000, The costs of capital for DSL is 15% (ignoring inflationary effect). Page 1 of 6

Answer 1

The book value of the plant is GHe1,800,000 on 1st of January. And we know that the plant is only going to operate for next 4 years and we are given the cash flow for next 4 years. And we also know that if the plant is sold in January 2014 the proceeds from the sell will be GHe1,320,000.

We need to calculate recoverable amount if any, for this purpose we need to compare the present value of cash flow of next 4 years at 15% since it is the cost of capital given to us and the proceeds from the sell of the plant. Whichever gives us the higher value should be selected since the purpose is to recover as much as we can from the plant.

Let's calculate the present value of the cash flow, since it is given to us that the cash flow is for the next 4 years so present value will be given by,

Present value = 550,00/(1+0.15) + 500,000/(1+0.15)^2 + 300,000/(1+0.15)^3 + 700,000/(1+0.15)^4

Present value = 550,00/(1.15) + 500,000/(1.15)^2 +300,000/(1.15)^3 + 700,000/(1.15)^4

Present value = 47,826.08 + 378,071.83 + 197,254.87 + 400,227.27

Present value = GHe 1,023,380.05

So the present value of cash flow of the next 4 years is GHe 1,023,380.05.

And we know that the proceeds from the sell of the plant if the plant were to be sold on january 2014 will be GHe 1,320,000.

As you can see the proceeds from the sell of plant on January 2014 is more than the present value of the next four years cash flow so the management should sell the plant in January 2014 to recover GHe 1,320,000 since it is better than the present value of GHe 1,023,380.05.

So the management of DSL can recover GHe 1,320,000 by selling the plant in January 2014, out of the current value of the plant which is GHe 1,800,000. It still can't recover the whole value of the plant as it is on January 2014 but still that's the best option that the management of DSL has given the present of the future cash flow and the proceeds from the sell of the plant in January 2014.