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Sky Limited is going into the manufacture of Smart Vehicle Tracking Device (SVTD) particularly designed for tracking the commercial vehicles such as lorries and trucks and has identified two potential machines that could be used to produce it. The Finance Manager has produced for the board the following potential cash flows from operating either machine. Year 012345 5 Capital Outlay Cash Inflow Cash Inflow Cash Inflow Cash Inflow Cash Inflow Residual Value Machine A £'000 -4,200 1,200 1,300 1,000 1,400 1,100 700 Machine B £'000 -4,800 1,100 1,400 1,200 1,000 1,300 900 The company has a cost of capital of 11% Required a) Calculate the Payback period for each of the machines and identify which should be invested in and explain why. b) Calculate the Accounting rate of return for each machine and identify which should be invested in and explain why. c) Calculate the Net present Value of each machine and identify which should be invested in and explain why. d) The Marketing Director believes that the production of this new SVTD is riskier and hence believes that the firm should not be discounting at the Cost of Capital but should add a 5% risk factor to it and discount at the Hurdle Rate of 16%. Recalculate the NPV for each machine utilising this new hurdle rate and identify which should be invested in and explain why.

Sky Limited is going into the manufacture of Smart Vehicle Tracking Device (SVTD) particularly designed for tracking the commercial vehicles such as lorries and trucks and has identified two potential machines that could be used to produce it. The Finance Manager has produced for the board the following potential cash flows from operating either machine. Year 012345 5 Capital Outlay Cash Inflow Cash Inflow Cash Inflow Cash Inflow Cash Inflow Residual Value Machine A £'000 -4,200 1,200 1,300 1,000 1,400 1,100 700 Machine B £'000 -4,800 1,100 1,400 1,200 1,000 1,300 900 The company has a cost of capital of 11% Required a) Calculate the Payback period for each of the machines and identify which should be invested in and explain why. b) Calculate the Accounting rate of return for each machine and identify which should be invested in and explain why. c) Calculate the Net present Value of each machine and identify which should be invested in and explain why. d) The Marketing Director believes that the production of this new SVTD is riskier and hence believes that the firm should not be discounting at the Cost of Capital but should add a 5% risk factor to it and discount at the Hurdle Rate of 16%. Recalculate the NPV for each machine utilising this new hurdle rate and identify which should be invested in and explain why.

FINANCIAL ACCOUNTING
FINANCIAL ACCOUNTING
10th Edition
ISBN:9781259964947
Author:Libby
Publisher:Libby
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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e) Given that a discount rate of 20% gives the following NEGATIVE NPVS for machine A of (£320,800) and for machine B of (£850,900), calculate the Internal rate of Return for each machine and state which project should be invested in. f) Critically evaluate each of the four methods i. Payback Method ii. Accounting Rate of Return iii. Net present Value Method iv. Internal Rate of Return g) As the Finance Manager, write a short memo to the Board to explain whether a hurdle rate should be used when undertaking the Net present value Computation. h) Based on your answers to parte and f, advise the board as to which machine should be invested in, fully justify your recommendation.
Transcribed Image Text:e) Given that a discount rate of 20% gives the following NEGATIVE NPVS for machine A of (£320,800) and for machine B of (£850,900), calculate the Internal rate of Return for each machine and state which project should be invested in. f) Critically evaluate each of the four methods i. Payback Method ii. Accounting Rate of Return iii. Net present Value Method iv. Internal Rate of Return g) As the Finance Manager, write a short memo to the Board to explain whether a hurdle rate should be used when undertaking the Net present value Computation. h) Based on your answers to parte and f, advise the board as to which machine should be invested in, fully justify your recommendation.
Sky Limited is going into the manufacture of Smart Vehicle Tracking Device (SVTD) particularly designed for tracking the commercial vehicles such as lorries and trucks and has identified two potential machines that could be used to produce it. The Finance Manager has produced for the board the following potential cash flows from operating either machine. Year 0 1 2 IAWN O 3 4 5 5 Capital Outlay Cash Inflow Cash Inflow Cash Inflow Cash Inflow Cash Inflow Residual Value Machine A £'000 -4,200 1,200 1,300 1,000 1,400 1,100 700 Machine B £¹000 -4,800 1,100 1,400 1,200 1,000 1,300 900 The company has a cost of capital of 11% Required a) Calculate the Payback period for each of the machines and identify which should be invested in and explain why. b) Calculate the Accounting rate of return for each machine and identify which should be invested in and explain why. c) Calculate the Net present Value of each machine and identify which should be invested in and explain why. d) The Marketing Director believes that the production of this new SVTD is riskier and hence believes that the firm should not be discounting at the Cost of Capital but should add a 5% risk factor to it and discount at the Hurdle Rate of 16%. Recalculate the NPV for each machine utilising this new hurdle rate and identify which should be invested in and explain why.
Transcribed Image Text:Sky Limited is going into the manufacture of Smart Vehicle Tracking Device (SVTD) particularly designed for tracking the commercial vehicles such as lorries and trucks and has identified two potential machines that could be used to produce it. The Finance Manager has produced for the board the following potential cash flows from operating either machine. Year 0 1 2 IAWN O 3 4 5 5 Capital Outlay Cash Inflow Cash Inflow Cash Inflow Cash Inflow Cash Inflow Residual Value Machine A £'000 -4,200 1,200 1,300 1,000 1,400 1,100 700 Machine B £¹000 -4,800 1,100 1,400 1,200 1,000 1,300 900 The company has a cost of capital of 11% Required a) Calculate the Payback period for each of the machines and identify which should be invested in and explain why. b) Calculate the Accounting rate of return for each machine and identify which should be invested in and explain why. c) Calculate the Net present Value of each machine and identify which should be invested in and explain why. d) The Marketing Director believes that the production of this new SVTD is riskier and hence believes that the firm should not be discounting at the Cost of Capital but should add a 5% risk factor to it and discount at the Hurdle Rate of 16%. Recalculate the NPV for each machine utilising this new hurdle rate and identify which should be invested in and explain why.
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