Calculate the present value of the net cash outflows incurred by equipment P and Q using the 8% discount rate chosen by Ball Limited. Use your results to recommend whether equipment P or Q should be chosen.
Ball Limited is a small independently-owned food processing company which operates a factory producing microwavable meals. Annual production of its “Gourmet” range is given in the following table:
| Year 1 | Year 2 | Year 3 | Year 4 | |
| Actual production (units) | 600,000 | 680,000 | 720,000 | 700,000 |
The owner of Ball Limited wants to retire at the end of four years, with all production being closed down. Despite the upcoming retirement in four years’ time, the company must replace the existing equipment now which makes the Gourmet range because of reliability problems. Managers are considering two options:
the purchase of equipment P or the rental of equipment Q.
Information on these two options is given below:
| Equipment P | Equipment Q | |
| Variable cost per meal ($) | 2.60 | 3.80 |
| Annual fixed cost ($) | 55,000 | 15,000 |
| Initial cost ($) | 2,500,000 | - |
| Annual rent cost ($) | 18,000 |
Additional relevant information has also been made available:
• Equipment P would have to be paid for immediately, while all other
• Equipment Q annual rental cost payments are made in advance at the start of each year of use.
• Annual fixed costs directly relate to each investment project.
Managers have chosen an 8% discount rate in the appraisal of the equipment options.
Required:
a) Calculate the present value of the net
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