Lesego Ltd is considering an investment in a new machine for the production of a new product, X. There are two possibilities, Machine A and Machine B. Both product X and the machine would have an expected life of five years. The following information is available: Product X Selling price $50 Variable cost 32 Increase in fixed overhead (excluding depreciation of the new machine) is $90,000 per year. Year   Sales units           1  10,000 2  15,000 3  20,000 4  20,000 5     5,000      Machine A                                           Machine B Initial cost ($000)                                 550                                             480 Residual value                                        50                                               30 The company's cost of capital is 10%, Required: a. Evaluate each machine, using the following methods: i.            Accounting rate of return ii.          Payback; iii.        Net present value. b. Discuss the importance of capital budgeting in organisations.

Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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Lesego Ltd is considering an investment in a new machine for the production of a new product, X. There are two possibilities, Machine A and Machine B. Both product X and the machine would have an expected life of five years.

The following information is available:

Product X Selling price $50

Variable cost 32

Increase in fixed overhead (excluding depreciation of the new machine) is $90,000 per year. Year

  Sales units           1  10,000

2  15,000

3  20,000

4  20,000

5     5,000

 

   Machine A                                           Machine B

Initial cost ($000)                                 550                                             480

Residual value                                        50                                               30

The company's cost of capital is 10%,

Required:

a. Evaluate each machine, using the following methods:

i.            Accounting rate of return

ii.          Payback;

iii.        Net present value.

b. Discuss the importance of capital budgeting in organisations.

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