Milan Ltd. wants to purchase a new machine for its factory operations at a cost of £380,000. This cost would be paid off in four installments: an immediate payment of £170,000, and a payment of £70,000 at the end of each of the next three years. The investment is expected to generate £80,000 in annual cash flows for a period of six years. The annual operating costs associated with the new machine are estimated to be £118,000 per year, including depreciation. These cash flows and costs will generally occur throughout the year and are recognized at the end of each year. Additional information: 1. The old machine can be sold for £25,000. 2. The new machine is expected to have the terminal disposal value £32,000 at the end of a six-year period. 3. Depreciation of the new machine is calculated using the straight-line method. 4. Major maintenance cost at the end of Year 3 will be £55,000 and at the end of Year 5 will be £30,000. 5. An additional cash investment in working capital of £20,000 will be required. It will be recovered at the end of the project. 6. Milan Ltd. will employ two highly skilled machine operators who each will earn £33,000 per year. 7. The new machine will allow Milan Ltd. to replace 7 skilled employees who each earns on average £28,000 per year. If the employees get fired, each of them is entitled to statutory redundancy pay 15% of their annual salary. There is a 70% probability that redundancy will result in strike action. If it is successful (a 60% probability), in addition to statutory redundancy pay employees will receive extra compensation equal to 20% of their annual salary. 50% of this compensation Milan Ltd. will be obliged to pay employees immediately upon redundancy, 30% - one year after redundancy whereas the remaining 20% - two years after redundancy. 8. To ensure that the new machine works at maximum efficiency, Milan Ltd. will need to lease a special energy generator at an annual lease cost of £45,000. The lease period would run for six years, with each payment being due at the beginning of the year. Required: Compare, contrast and critically discuss the merits and drawbacks of different capital budgeting methods that recognize time value of money.
Milan Ltd. wants to purchase a new machine for its factory operations at a cost of £380,000. This cost would be paid off in four installments: an immediate payment of £170,000, and a payment of £70,000 at the end of each of the next three years. The investment is expected to generate £80,000 in annual
Additional information:
1. The old machine can be sold for £25,000.
2. The new machine is expected to have the terminal disposal value £32,000 at
the end of a six-year period.
3. Depreciation of the new machine is calculated using the straight-line method.
4. Major maintenance cost at the end of Year 3 will be £55,000 and at the end of
Year 5 will be £30,000.
5. An additional cash investment in
will be recovered at the end of the project.
6. Milan Ltd. will employ two highly skilled machine operators who each will earn
£33,000 per year.
7. The new machine will allow Milan Ltd. to replace 7 skilled employees who each
earns on average £28,000 per year. If the employees get fired, each of them is entitled to statutory redundancy pay 15% of their annual salary. There is a 70% probability that redundancy will result in strike action. If it is successful (a 60% probability), in addition to statutory redundancy pay employees will receive extra compensation equal to 20% of their annual salary. 50% of this compensation Milan Ltd. will be obliged to pay employees immediately upon redundancy, 30% - one year after redundancy whereas the remaining 20% - two years after redundancy.
8. To ensure that the new machine works at maximum efficiency, Milan Ltd. will need to lease a special energy generator at an annual lease cost of £45,000. The lease period would run for six years, with each payment being due at the beginning of the year.
Required:
Compare, contrast and critically discuss the merits and drawbacks of different capital budgeting methods that recognize time value of money.
Step by step
Solved in 2 steps
