Lighting System ACCA ICDM (Old Syllabus)

A company is considering the improvement of the lighting system in one of its offices. The following information is available. (i) The building will be sold in three years' time. It is proposed that the existing lighting be replaced by either large or small 'task-focused' lighting units at a cost of $750 per unit for small units and $1,250 per unit for large units. The total requirement will be for 80 small units or 50 large units. All purchases will be paid for immediately (year 0). The quantity of electricity used will be reduced from that of the existing lighting system by 40% if small units are introduced, and by 30% if large units are introduced. The electricity cost allocated to the office in the year prior to purchase (year 0) is $50,000 for the existing lighting system. This includes a $10,000 share of standing charges paid by the company and the balance at a constant cost per unit of electricity used. The existing lighting system has maintenance costs of $12,000 per annum in the year prior to purchase (year 0). This includes a $5,000 share of the salary of an electrician who will be retained by the company whether or not he undertakes this work. The balance is for spare parts. Most of the spare parts are purchased as required but $1,000 worth per annum are taken from inventory purchased some time ago. The spares parts inventory is sufficient to last for a further two years (at $1,000 per annum). Such spare parts would currently (year 0) cost 30% more to purchase than the original purchase price. Existing inventories could not be sold or used elsewhere if not used for lighting maintenance. The new lighting system (large or small units) will have maintenance costs of $5,000 in year 1 (at year 1 prices) which will include a $3,000 share of the salary of the electrician currently used for lighting maintenance. The remaining cost is for spare parts which will be specially purchased. The quantity of spare parts required will increase by 25% in year 2 and by a further 10% of the year 2 level in year 3. It is estimated that the task-focused lighting (large or small units) will increase the saleable value of the building by $15,000 at the end of year 3 with the cash flow relating to the sale taking place at the end of year 4. It is estimated that all costs will increase because of price level changes according to the following index table (all indices expressed in terms of a year 0 index of 100). Index (Ignore taxation) 0 100 1 105 2 110 3 115

(ii)

(iii)

(iv)

(v)

(vi)

Required
(i) Determine whether it is financially worthwhile to introduce either of the task-focused lighting systems on 1 January year 1 where the cost of capital is 10%. Your answer should include all relevant working calculations and should give reasons for the exclusion of any of the above data from the decision model. (22 marks) (ii) Calculate the level of estimated increase in the saleable value of the building at which the company would be indifferent on financial grounds to a change from the existing lighting to the task-focused (small) lighting units, given that all other variables remain as in part (a)(i). (3 marks)