Carbon plc is planning to buy a new machine with an expected life of five years. The machine would cost £900,000 and will generate cash flows in the subsequent years, as shown below. Year 1 2 3 4 5 Cash flow(£) 50,000 350,000 120,000 80,000 800,000 After the end of the fifth year, business activity from this machine will cease and no more cash flows will be generated. The initial cost of £900,000 in the machine is to be depreciated over the five-year using the straight-line method. The machine will have no scrap value at the end of five years. The management judges that the cash inflows shown above are also an accurate estimation of the profit before depreciation for each of the years. The board of directors is used to evaluating project proposals on the basis of a payback rule and requires investments to achieve payback in three years. The Accounting Rate of Return is calculated on the basis of the initial investment rather than average investment and the management expects a rate of 15% for worthwhile projects. Carbon plc’s cost of capital for investment appraisal is 11%. Required: Appraise the project by first calculating (a) i) the payback period ii) the accounting rate of return (using initial investment in your calculation) iii) the Net Present Value iv) the Internal Rate of Return (IRR) (b) Write a briefing note to the board of directors advising them on the investment.
Carbon plc is planning to buy a new machine with an expected life of five years. The machine would cost £900,000 and will generate cash flows in the subsequent years, as shown below.
Year 1 2 3 4 5
Cash flow(£) 50,000 350,000 120,000 80,000 800,000
After the end of the fifth year, business activity from this machine will cease and no more cash flows will be generated. The initial cost of £900,000 in the machine is to be
The management judges that the
Carbon plc’s cost of capital for investment appraisal is 11%.
Required:
Appraise the project by first calculating
(a)
i) the payback period
ii) the accounting rate of return (using initial investment in your calculation)
iii) the
iv) the
(b) Write a briefing note to the board of directors advising them on the investment.
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