- 15 Marks
FM – L2 – Q72 – Discounted cash flow
Calculate NPV for two machines with given cash flows, tax, and capital allowances.
Question
72 NANTWI PLC
The directors of Nantwi Plc are meeting to decide about the replacement of a machine. The existing machine has to be replaced soon, and there is a choice of two machines that could be purchased to replace it. These are Machine A and a larger Machine, B. The following information is available about each machine:
| Machine A | Machine B | |
|---|---|---|
| Expected working life | 4 years | 5 years |
| Initial cost | GH₵600,000 | GH₵750,000 |
| Residual value | GH₵0 | GH₵0 |
| Working capital requirement | GH₵100,000 | GH₵200,000 |
The forecast pre-tax cash flows that will be earned using each machine are as follows:
| Year 1 | Year 2 | Year 3 | Year 4 | Year 5 | |
|---|---|---|---|---|---|
| GH₵000 | GH₵000 | GH₵000 | GH₵000 | GH₵000 | |
| Machine A | 470 | 520 | 490 | 450 | |
| Machine B | 580 | 640 | 500 | 500 | 400 |
Nantwi Plc uses 10% as its cost of capital for capital expenditure evaluation.
Taxation at 30% is payable one year in arrears. Capital allowances are available at the rate of 25% each year on the reducing balance method. Inflation should be ignored.
Required
(a) Calculate the NPV with each of the machines.
(b) Calculate the payback period for each machine.
(c) Recommend with reasons which machine should be purchased.
Find Related Questions by Tags, levels, etc.
- Tags: Capital Budgeting, Investment decision, Machine Replacement, NPV
- Level: Level 2
- Topic: Capital budgeting
