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.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
Related questions
Question
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.
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.
Expert Solution
This question has been solved!
Explore an expertly crafted, step-by-step solution for a thorough understanding of key concepts.
Step by step
Solved in 5 steps with 4 images
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, accounting and related others by exploring similar questions and additional content below.Recommended textbooks for you
Accounting
Accounting
ISBN:
9781337272094
Author:
WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.
Publisher:
Cengage Learning,
Accounting Information Systems
Accounting
ISBN:
9781337619202
Author:
Hall, James A.
Publisher:
Cengage Learning,
Accounting
Accounting
ISBN:
9781337272094
Author:
WARREN, Carl S., Reeve, James M., Duchac, Jonathan E.
Publisher:
Cengage Learning,
Accounting Information Systems
Accounting
ISBN:
9781337619202
Author:
Hall, James A.
Publisher:
Cengage Learning,
Horngren's Cost Accounting: A Managerial Emphasis…
Accounting
ISBN:
9780134475585
Author:
Srikant M. Datar, Madhav V. Rajan
Publisher:
PEARSON
Intermediate Accounting
Accounting
ISBN:
9781259722660
Author:
J. David Spiceland, Mark W. Nelson, Wayne M Thomas
Publisher:
McGraw-Hill Education
Financial and Managerial Accounting
Accounting
ISBN:
9781259726705
Author:
John J Wild, Ken W. Shaw, Barbara Chiappetta Fundamental Accounting Principles
Publisher:
McGraw-Hill Education