Question

Design Layout References mew... 12 A A Aa A Uab x, x' ADA Assessment 3 2019 session 312) (2) Mailings Review View Tell me what you want to do VERY E ALT AaBbceDdE 3 E a AaB CcDdE AaBbc No Spacing Headin (7 marks) 3. Futurist Enterprises is considering buying one of two possible available machines as part of its proposed product expansion. Machine no. 1 would cost $150 000 and is expected to earn annual net cash inflows of $50 000, $52 000, $55 000, $38 900 and $36 500 before it wears out sufficiently to be unreliable and will be sold for an estimated $20 200. Machine No.2 would cost $115 000 and is expected to earn annual net cash inflows of $40 000, $42 000, $45 000, $32 900 and $32 500 before it wears out sufficiently to be unreliable and will be sold for an estimated $10 100 (15 Marks) Required a. If funds can earn 5 per cent, what is the NPV of each Machine? b. Advise management on your recommendation regarding purchase of which machine subsequent to your NPV calculations. e. What advice would you give management if the required payback period was two years? Show calculations for a and c.

Answer 1

a)

Machine no 1
Year	Cash flows
0	-$150,000.00
1	$50,000
2	$52,000
3	$55,000
4	$38,900
5	$36,500

$50,000 $52,000 $55,000 (1+0.05)1 *(1+0.05)2 + (1+0.05) x NPV machine no 1 = -$150,000+ $38,900 $36,500 $20,200 (1+0.05)4 * (1+0.05)5*(1+0.05) 05

NPV machine no 1 = $68,724.7

Machine no 2
Year	Cash flows
0	-$115,000.00
1	$40,000
2	$42,000
3	$45,000
4	$32,900
5	$32,500

$40,000 $42,000 $45,000 (1+0.05)1 + (1+0.05)2 + (1+0.05) NPV machine no 2 = -$115,000+ $32,900 $32,500 $10,100 (1+0.05)4 * (1+0.05)5*(1+0.05)

NPV machine no 2 = $60,508.29

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b)

Subsequent to the NPV calculation it is advisable for the management to purchase machine no 1 because the net present value (NPV) of machine no 1 is higher than that of machine no 2.

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c)

Machine no 1
Year	Cash flows	Cumulative cash flows
0	-$150,000.00	-$150,000.00
1	$50,000	-$100,000.00
2	$52,000	-$48,000.00
3	$55,000	$7,000.00
4	$38,900	$45,900.00
5	$36,500	$82,400.00

$48000 Payback period machine no 1 = 2 years + $55.000

Payback period machine no 1 = 2.87 years

Machine no 2
Year	Cash flows	Cumulative cash flows
0	-$115,000.00	-$115,000.00
1	$40,000	-$75,000.00
2	$42,000	-$33,000.00
3	$45,000	$12,000.00
4	$32,900	$44,900.00
5	$32,500	$77,400.00

$33,000 Payback period machine no 2 = 2 years + een

Payback period machine no 2 = 2.73 years

Both the machines have a payback period of greater than 2 years, therefore the management should rely upon the NPV criteria to decide which machine to purchase. The payback period method does not consider the time value of money. Thus according to the NPV criteria the management should purchase machine no 1 which has a higher NPV compared to machine no 2.