1. A company is considering the following investment projects. Both would involve
purchasing machinery with a life of 5 years.
• Project 1 would generate annual cash flows of £150,000; the machinery would
cost £350,000 and have a scrap value of £45,000.
• Project 2 would generate annual cash flows of £250,000; the machinery would
costs £800,000 and have a scrap value of £350,000.
The company’s discount rate is 12%. Assume that the annual cash flows arise on the
anniversaries of the initial outlay.
Calculate the net present value and payback for each project and state which project the
company should accept and why.
2. A firm can buy a new printer for £2,000 payable immediately. The new printer
would make cash savings for the firm of £2,000 in the first year of operation,
£4,000 in the second year and £2,000 in the fifth year.
The firm makes no savings from the printer in the third and fourth year of its life, and
will need to spend £4,000 on it in year 3 because of expensive repairs. The machine is
scrapped at the end of 5 years, but there is no scrap value.
As an alternative to outright purchase, the firm could hire a printer, paying £1000 per
annum, in advance, for the 5 years. The firm would still expect to make the same costs and
savings as in outright purchase, but the hire company would meet the repair cost of year 3.
If the going rate of interest is 10%, using net present value, advise the firm as to which
of the two methods (buy or hire) should be used to obtain the printer.
3. Trigger PLC is a manufacturer of computer components and a decision is required
on a proposal to invest £1,800,000 on a new machine in order to move into a new
market for components. The financial details are as follows:
The company has a target rate of return of 11% and a payback criterion of 4 years.
(a) Calculate the payback period.
(b) Calculate the project’s net present value.
(c) Advise the company on whether it should proceed with the project. Provide
reasons for your advice.
4. A company is considering an investment of £1.4 million in a project that has a
seven-year life. The company has estimated its discount rate at 12%. Details of the
sales and costs arising from this project are as follows:
Sales volume: 250,000 units per annum
Note that the annual overhead includes £200,000 per year depreciation on the asset. It also
includes apportioned fixed overheads of a further £50,000 per year.
(a) Calculate the net present value of the project. Provide a commentary on the discounting process and on the net present value that you have calculated.
(b) Carry out a sensitivity anlaysis on five variables of this project, including the life
of the project and the discount rate. Identify what you consider to be the most critical variable and advise management what they should do, if anything, before
adopting this project.