- 20 Marks
BMF – May 2021 – L1 – SB – Q4 – Investment Decisions
Evaluate two equipment options using NPV and Discounted Payback Period to maximize shareholder value.
Question
Felfred Limited is contemplating buying a new item of equipment to facilitate the improvement of the quality of services provided to customers of the company. Two models of the needed equipment are currently available in the market. The two machines, Xetoy and Whytox would cost N750,000 and N1,500,000 respectively. Additional information in relation to the two equipment is as stated below:
| Equipment | Xetoy | Whytox |
|---|---|---|
| Estimated Lifespan | 5 years | 5 years |
| Expected Cash inflows / Year | ||
| 2021 | N500,000 | N500,000 |
| 2022 | N500,000 | N500,000 |
| 2023 | N300,000 | N600,000 |
| 2024 | N200,000 | N600,000 |
| 2025 | N100,000 | N600,000 |
| Disposal value | N50,000 | N100,000 |
Based on Net Present Value (NPV) and Discounted Payback Period methods of investment appraisal, you are required to select the equipment in which the value of shareholders will be maximised. Costs of installation for Xetoy and Whytox are N50,000 and N100,000 respectively. The company’s minimum required rate of return is currently at 12%.
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