A toy manufacturer that specialises in making fad items has just developed a £50000 moulding machine for producing a special toy. The machine has been used to produce only one unit so far. The company will depreciate the £50 000 initial machine investment evenly over four years, after which production of the toy will be stopped. The company's expected annual costs will be direct materials, £10 000; direct manufacturing labour, £20 000; and variable manufacturing overhead, £15 000. Variable manufacturing overhead varies with direct manufacturing labour costs. Fixed manufacturing overhead, exclusive of depreciation, is £7500 annually, and fixed marketing and administrative costs are £12 000 annually.

Suddenly a machine salesperson appears. He has a new machine that is ideally suited for producing this toy. His automatic machine is distinctly superior. It reduces the cost of direct materials by 10% and produces twice as many units per hour. It will cost £44000 and will have a zero terminal disposal value at the end of four years.

Production and sales of 25 000 units per year (sales of £100 000) will be the same whether the company uses the old machine or the new machine. The current disposal value of the toy company's moulding machine is £5000. Its terminal disposal value in four years will be £2600.

Required

1. Assume that the required rate of return is 18%. Using the net present-value method, show whether the new machine should be purchased what is the role of the book value of the old machine in the analysis?

2. What is the payback period for the new machine?

3. As the manager who developed the £50 000 old moulding machine, you are trying to justify not buying the new £44 000 machine. You question the accuracy of the expected cash operating savings. By how much must these cash savings fall before the point of indifference - the point where the net present value of investing in the new machine -reaches zero?