QT – May 2019 – L1 – Q2b – Mathematics of Business Finance

Calculate NPV and IRR for two machines and determine which machine yields a better return.

Question

BonBone Company Ltd wants to make a decision on which of the two machines to purchase. Each will involve a GH¢10,000 investment. The expected net incremental cash flows are given by the table below:

Year	Machine I (GH¢)	Machine II (GH¢)
1	5,000.00	2,000.00
2	4,000.00	3,000.00
3	2,000.00	5,000.00
4	2,000.00	4,000.00

Required:

i) If the company’s cost of capital is 10%, calculate the Net Present Value (NPV) of Machine I and Machine II and determine which machine should be purchased for higher returns. (8 marks)

ii) If the initial investment for Machine I is changed to GH¢4,000 and Machine II is changed to GH¢2,000, calculate the Internal Rate of Return (IRR) for Machine I and Machine II. (6 marks)

iii) If the IRRs in (ii) above are to be used as the basis of selection, determine which machine should be purchased for higher returns. (2 marks)

Answer