Question

a) Provide a critique of three financial project selection models of your choice by discussing the advantages and disadvantages of each. b) A project requires the purchase of a new piece of machinery. You are the project manager and you must choose between two potential machines (Machine A and Machine B), either of which would be suitable. The cost of each machine is identical at £311,000. However, they differ in performance such that the projected future cash flows are different for each machine. Projected cash flows over a 5 year period are as shown in Table Q2a 0 2 4 5 Year Cash Flow: Machine A Cash Flow: Machine B -£311,000 -£311,000 1 10,000 200,000 70,000 111,000 3 100,000 55,000 131,000 40,000 250,000 32,000 Five year cash flow figures for Machine A and Machine B. Show which machine would be the preferred choice based on a Payback Period estimate. For each machine calculate Return on Investment. For each machine, calculate the Net Present Value (NPV) after 5 years assuming a 이 discount (inflation) rate of 1% for each year of the project. Table Q2b provides a list of discount factors for a range of discount (inflation) rates. For each machine, calculate the Internal rate of return after 5 years assuming a discount (inflation) rate of 1% for each year of the project. i. ii. iv. v. The project manager decides to purchase Machine A. Suggest why. Discount Factors for given discount (inflation) rates over a 5-year period Years 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 1 0.9901 0.9804 0.9709 0.9615 0.9524 0.9434 0.9346 0.9259 0.9174 0.9091 N 0.9803 0.9612 0.9426 0.9246 0.9070 0.8900 0.8734 0.8573 0.8417 0.8264 3 0.9706 0.9423 0.9151 0.8890 0.8638 0.8396 0.8163 0.7938 0.7722 0.7513 4 0.9610 0.9238 0.8885 0.8548 0.8227 0.7921 0.7629 0.7350 0.7084 0.6830 5 0.9515 0.9057 0.8626 0.8219 0.7835 0.7473 0.7130 0.6806 0.6499 0.6209 Discount Factors for given discount (inflation) rates over a 5-year period.

Answer 1

ů Pone No. Date: 1 . Cal of Pay Back period Year 1 Machine A Machine B В Total flows Cummulative Total Cummulative (in $) (in f) flows ins) Flow Flows (in of (311,000) (311,000) (311,000) (311,000) 10,000 (301,000). 200,000 (1,11,000) 70,000 (231,000) 111000 100,000 (131,000) 55.000 55000 40,000 95000 950,000 250,000 32,000 187000 2 O 3 4 131,000 0 5 + uncovered cost Cash flow during next year • Pay Back period Formula , Full years until recovery 4 years 4 4 years Machine A z + O 250 000 Machine B 2 years + O 55000 2 years So, according to pay back period estimate Machine ' B pay back period means it will recover its cost Machine A. earlier than

(9) Return on Investment Aug Net income Original investment Ang Net Income Machine A 10000 + 70000 + 100000 + 13.000 950000 5 1,12,200 Z Rol (Machine A) 360774 2 112,200 311,000 Aug Net Income Machine B 200.000+ 111000 + 55000 + 40000 + 32000 5 438000 87,600 5 Rol (Machine B) 87600 28.167/ 31000 Acc - to ROL, Machine A should be selected because it has higher return on original amount invested

Page No. Date: / 62 b C @ Calculation of NPV I T ㅠ Year Cash Flow PVF Machine A Machine B @14 alo (31000) ( 311000) I | 10,000 200000 0-990) 2. 70,000 111000 0.9803 100,000 55000 0.9706 e 4 131000 40000 0.9610 f 5 250.000 32000 0.9515 PV of Cash inflow ( (b tof h ก Pv of cash outflow Краа NPV ( (9-h) TT 2 IxI Present Value Machine A Machine B (311000) (311000) 9901 198,020 68,621 108.813 97,060 53.383 195,891 38,440 237,875 30,448 5,39 348 499104 311,000 311,000 228348 1,18,104 Acc. to NPV Machine A should be selected

(iv) ® Cal- of CRB (Internal rete of Return) Machine A 386,767 Machine B 3,62,061 PV of Cash inflow (when PVF is 10%) I PV of Out flow I 311.000 At 10% NPV I-I 75,767 AL1 NPV 298,348 3,11 000 51,061 L18,104 2 IRR MP Lowey Rate + (Diffin Rate, 2 * Lower Rate NPV Lower Rate NPV – Higher Route NPV

Page No. Date : IRR of Machine A * 10% + 288348 (104-111-) 228348 - 75767 1% + 298348 X х 914 15258) 14.469 % IRR of Machine B 11. + 118104 X х 11 8104-51061 2 11% + 18104 91/2 * 67043 16.8545/ (1) The Purchase Manager decides to purchase Maching A because > NPV of Machine A is higher than Machine B > Retumºon Investment is higher in Machine A