Corporate Finance at Universal Manufacturing Essay

1710 Words 7 Pages
Question:

Universal Manufacturing Technology Limited’s CEO has decided to purchase a few machineries to improve the company’s operations. However, he is uncertain how to evaluate the machineries.
He has asked your advice on the various techniques to evaluate the investment. Discuss the several methods of investment appraisal techniques considering the methods using time value of money and not using time value of money.
Beside the above, the CEO is also keen to know about the following terms:

(a) Sunk Cost
(b) Relevant Cost
(c) Incremental Cost
(d) Opportunity Cost

In your discussion to the above terms, use appropriate examples.
Introduction:
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Method that not using time value of money:
i. Payback Method ii. Acounting rate of return (ARR)
Payback Method
This is literally the amount of time required for the cash inflows from a capital investment project to equal the cash outflows. The usual way that firms deal with deciding between two or more competing projects is to accept the project that has the shortest payback period. Payback is often used as an initial screening method.

Initial payment

Payback period = Annual cash inflow
So, if $4 million is invested with the aim of earning $500,000 per year per year (net cash earnings), the payback period is calculated Payback period = $4,000,000 $ 500,000

= 8 years ~ Advantages of payback:
- It is simplicity
- In a business environment of rapid technological change, new plant and machinery may need to be replaced sooner than in the past, so a quick payback on investment is

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