Investment Appraisal

LNM

Question 1

Company XYZ is considering an investment in new machinery costing $150 000. A deposit has been previously made amounting to $15 000. The useful life of the machinery is 10 years, with residual value of $12 000. There are two possible configurations for the machinery, namely option A or option B, which have different cash flow implications and will have annual licence costs of $5 000. The Board of Directors has a policy requiring payback within 2 years for project approval.

The expected annual cash flows are as follows:

Cash Flow Option A Option B

Year 1 45,000 40,000
Year 2 38,000 40,000
Year 3 34,000 40,000
Year 4 46,000 40,000

Required:

a) Calculate the payback period for the two projects, clearly showing your workings. [5 marks]
b) Calculate the ARR for the two proposals [5 marks]