Epica PLC is considering marketing a new product with a four-year life. Epica will need to install new equipment to manufacture the product. Epica has to choose between two machines both of which would be suitable. Machine 1 costs K460,000 to purchase and install, and will have a residual value of K20,000 at the end of four years. Machine 2 costs K630,000 to purchase and install, and has a residual value of K30,000 at the end of four years. Machine 2 takes slightly longer to install and commission, but once in operation it has slightly lower operating costs per unit, and will eventually produce more output. The following projections have been prepared of the cash flows from product sales and operating costs for the two machines: Year 1 Year 2 Year 3 Year 4 Machine 1 Sales K'000 1,340 1,460 1,300 820 Costs K'000 1,160 1,260 1,140 760 Machine 2 Sales K'000 700 1,400 1,600 900 Costs K'000 610 1,100 1,240 750 The company's cost of capital is 12% p.a. All capital investments have to achieve a payback period of three years or less. Required: Using the NPV method and paying attention to the condition set on payback, do calculations to show which project should be accepted, and advise the management.
Epica PLC is considering marketing a new product with a four-year life. Epica will need to install new equipment to manufacture the product. Epica has to choose between two machines both of which would be suitable. Machine 1 costs K460,000 to purchase and install, and will have a residual value of K20,000 at the end of four years. Machine 2 costs K630,000 to purchase and install, and has a residual value of K30,000 at the end of four years. Machine 2 takes slightly longer to install and commission, but once in operation it has slightly lower operating costs per unit, and will eventually produce more output. The following projections have been prepared of the cash flows from product sales and operating costs for the two machines: Year 1 Year 2 Year 3 Year 4 Machine 1 Sales K'000 1,340 1,460 1,300 820 Costs K'000 1,160 1,260 1,140 760 Machine 2 Sales K'000 700 1,400 1,600 900 Costs K'000 610 1,100 1,240 750 The company's cost of capital is 12% p.a. All capital investments have to achieve a payback period of three years or less. Required: Using the NPV method and paying attention to the condition set on payback, do calculations to show which project should be accepted, and advise the management.
Chapter10: Project Cash Flows And Risk
Section: Chapter Questions
Problem 13PROB
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Transcribed Image Text:QUESTION ONE
Epica PLC is considering marketing a new product with a four-year life. Epica will need
to install new equipment to manufacture the product. Epica has to choose between two
machines both of which would be suitable.
Machine 1 costs K460,000 to purchase and install, and will have a residual value of
K20,000 at the end of four years. Machine 2 costs K630,000 to purchase and install, and
has a residual value of K30,000 at the end of four years. Machine 2 takes slightly longer
to install and commission, but once in operation it has slightly lower operating costs per
unit, and will eventually produce more output.
The following projections have been prepared of the cash flows from product sales and
operating costs for the two machines:
Year 1
Year 2
Year 3
Year 4
Machine 1
Sales K'000
1,340
1,460
1,300
820
Costs K'000
1,160
1,260
1,140
760
Machine 2
Sales K'000
700
1,400
1,600
900
Costs K'000
610
1,100
1,240
750
The company's cost of capital is 12% p.a. All capital investments have to achieve a
payback period of three years or less.
Required:
Using the NPV method and paying attention to the condition set on payback, do
calculations to show which project should be accepted, and advise the management.
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