Lituli Ltd is evaluating the investment in new machinery to manufacture either product Angel or Product Beauty. Two alternative machines are being considered: Machine X to manufacture product Angel and Machine Y to manufacture product Beauty. Production and sales units are expected to be:
| Product Angel | Product Beauty | |
| Year 1 | 19 000 | 15000 |
| Year 2 | 20000 | 15000 |
| Year 3 | 20000 | 23000 |
| Year 4 | 19000 | 25000 |
Details of the two machines are
| x | y | |
| Cost | N$310 000 | N$350 000 |
| Life | 4 years | 4 years |
| Residual value | N$30 000 | N$50 000 |
Both products will sell for N$20 per unit.
Product A will have variable costs of N$10 per unit.
Product B will have variable costs of N$9 per unit
Fixed costs (inclusive of straight—line depreciation of the machine) will be N590,000 per annum for product A, and N$120,000 per annum for product B.
The unit selling price and all annual fixed and unit variable costs will remain constant over the four-year period.
The company has a cost of capital of 10% per annum
Discount factors at 10% are as shown below
| Year 1 | 0.909 |
| Year 2 | 0.826 |
| Year 3 | 0.751 |
| Year 4 | 0.683 |
Required
1. Calculate the annual cash flow arising from the production of both product Angel and product Beauty. Assume that each machine will sell for its residual value at the end of four years
2.Evaluate each machine, using each of the following methods:
i) Payback; [4]
ii) Net present value.
3. Advice management as to which machine should be purchased, giving two reasons
4. Another method of Capital Investment Appraisal is the Accounting Rate of Return. State one advantage and one disadvantage associated with this method of appraisal.
1 Answer