You work for J Limited which provides consultancy services to the following clients.
R Limited currently has 20 lorries each with a 12-ton carrying capacity. The driver of each lorry earns £15,000 per annum, with employer contributions to national insurance and employer contributions to a pension scheme making up an additional £5,000 per annum per worker. The depot manager, staff and facilities cost £128,000 per annum.
Each lorry originally cost £50,000 and the average current trade-in price is £3,000 per vehicle. The lorries are fully depreciated in the accounts but would be operable for a further four years if overhauled immediately at an average cost of £5,000 per vehicle. The annual running and repair costs per vehicle would then be £15,000 per annum per vehicle for repairs and a further £9,000 per annum per vehicle in tyres, licensing and other operating costs. At the end of four years it is unlikely that the lorries will be of any value.
The management of R Limited is considering a proposal to replace the entire fleet now with 12 new lorries each of 20 tons capacity. Each new lorry would cost £77,000 and have an estimated useful life of 8 years, at the end of which time a trade-in value of £5,000 would be a reasonable estimate. Annual average repair costs would be £13,000 per lorry, operating costs per lorry £14,000 and depreciation £9,000 on a straight-line basis. It is anticipated that there will be an additional cost of £1,500 per annum extra for each driver as a productivity award, and the eight drivers laid off would on average be entitled to two years’ wages each as redundancy pay.
The cost of capital to R Limited is estimated at 12%.
You are to prepare a report to the management of R Limited concerning the proposed replacement. You recommendation should be made after using the equivalent annual annuity approach. The report should include your reasons and analysis and any additional factors that may need consideration.