Bunnings Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 8%. The cash flows of the projects are provided below.     Equipment 1 Equipment 2 Cost $186,000 $195,000 Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5   86 000 93 000 83 000 75 000 55 000   97 000 84 000 86 000 75 000 63 000   Required: 1. Identify which option of equipment should the company accept based on Profitability Index? 2. Identify which option of equipment should the company accept based on discounted pay back method if the payback criterion is maximum 2 years?

EBK CONTEMPORARY FINANCIAL MANAGEMENT
14th Edition
ISBN:9781337514835
Author:MOYER
Publisher:MOYER
Chapter10: Capital Budgeting: Decision Criteria And Real Option
Section10.A: Mutually Exclusive Investments Having Unequal Lives
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Bunnings Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 8%. The cash flows of the projects are provided below.

 

 

Equipment 1

Equipment 2

Cost

$186,000

$195,000

Future Cash Flows

Year 1

Year 2

Year 3

Year 4

Year 5

 

86 000

93 000

83 000

75 000

55 000

 

97 000

84 000

86 000

75 000

63 000

 

Required:

1. Identify which option of equipment should the company accept based on Profitability Index?

2. Identify which option of equipment should the company accept based on discounted pay back method if the payback criterion is maximum 2 years?

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