Question

Question 2 [20 Marks] Kanye &Jwaneng Enterprises intends buying a new machine and the following details relate to the machine. Purchase price P300,000 Expected economic life 5 years Scrap vale 0 Minimum required rate of return Expected net cash inflow End of year 1 P40,000

Answer 1

a)

Year	Cashinflows	Cumulative Cashflows
1	40,000	40,000
2	80,000	120,000
3	150,000	270,000
4	90,000	360,000
5	60,000	420,000
	Payback period=	3+	(300,000-270,000)/90000
		3+	0.333
		3.33	years
		3 Years 4 Months

b)

Advantages:

This method has a very simplistic approach compared to other capital budgeting methods

This method concentrates on liquidity (how quickly do we get our investment back)

Disadvantages:

This method does not consider time value of money

Ignores profitability of the project

c)

ARR=	Avg annual profit / Avg investment
Avg investment=	(Book value at year 1+ Book value at end)/2
Avg annual profit=	total profit over investment period/number of years
Avg annual profit=	24,000	120000/5
Avg investment=	150,000	(300,000+0)/2
ARR=	16.00%
	Year
	1	40,000
	2	80,000
	3	150,000
	4	90,000
	5	60,000
	Total inflows	420,000
	Less: Dep for 5 years	(300,000)
	Total profit over investment	120,000

d)

Year	Cashinflows	PV.Factor @12%	Present value
1	40,000	0.893	35,714.29
2	80,000	0.797	63,775.51
3	150,000	0.712	106,767.04
4	90,000	0.636	57,196.63
5	60,000	0.567	34,045.61
		Total PV of inflows	297,499.07
	Total PV of inflows	297,499.07
	Purchase price	300,000.00
	NPV	(2,500.93)
Company should not buy new machine as NPV is negative and company is getting return less than 12 %

Please like the solution if satisfied with the answer and if any queries please mention it in comments...thanks