Nicol Limited is considering investing in a new machine. The machine would cost £500,000. It would have a life of five years and a nil residual value. The company uses the straight-line method of depreciation.

It is expected that the machine will earn the following extra profits for the company during its expected life:

Year Profits

£000

1 .......... 200

2 .......... 120

3 .......... 120

4 .......... 100

5 .......... 60

The above profits also represent the extra net cash flows expected to be generated by the machine (i.e. they exclude the machine’s initial cost and the annual depreciation charge). The company’s cost of capital is 18%.

Required:

(a) Calculate:

(i) The machine’s payback period; and

(ii) Its net present value.

(b) Advise management as to whether the new machine should be purchased.