Dr Philip E Dunn tests your knowledge of investment appraisal.
Philip Stentiford is an agricultural contractor based in North Yorkshire. He is considering investing £120,000 in one of two machines.
The forecasted cash flow from these over a five-year period is listed below:
Machine (A) Yr1 £40,000 Yr2 £50,000 Yr3 £30,000 Yr4 £45,000 and Yr 5 £25,000
Machine (B) Yr1 £25,000 Yr2 £35,000 Yr3 £50,000 Yr4 £40,000 and Yr5 £25,000
The business has a cost of capital of 12% and discounts projects at that rate.
NPV Factors at 12% Yr1 0.893 Yr2 0.797 Yr3 0.712 Yr4 0.636 and Yr 5 0.567
Q1: Calculate the Net Present Value of Machine (A).
Q2: Calculate the Net Present Value of Machine (B).
Q3: Calculate the Discounted Payback Index/ Profitability Index for Machine (A).
Q4: Calculate the Discounted Payback Index/ Profitability Index for Machine (B).
Q5: Calculate the Discounted Payback Period for Machine (A).
Q6: Calculate the Discounted Payback Period for Machine (B).
Q7: Management need to know what Discounted Cash Flow Rate the machine with the higher NPV is achieving.
Discount the machine showing the higher Net Present Value at 20% and calculate its Net
NPV Factors at 20% Yr1 0.833 Yr2 0.694 Yr3 0.579 Yr4 0.482 and Yr5 0.402
Q8: Calculate the Internal Rate of Return (IRR) for the machine relevant to Q7.
Management suggest that if the second machine could achieve an Internal Rate of Return of 16% they may invest in both machines.
Q9: Calculate the Net Present Value of your second choice machine using a rate of 20%.
Q10: Calculate the Internal Rate of Return of the machine relevant to Q9.
Q11: Bearing in mind your answer to Q10, is it likely that the management would invest in both machines?
• Dr Philip E Dunn is a freelance author and technical editor for Kaplan and Osborne Books
Q5: 3 years 10 months
Q6: 4 years 7 months
Q7: £ (2,870)
Q9: £ (16,605)
Q11: Although the second machine (B) has an Internal Rate of 13.97% that is an excess of the Cost of Capital. It is not yielding the 16% mentioned by management therefore on this criteria would not be adopted.