Question: Exercise 9.1: Basic computations A company is considering investing in a new production facility at a cost of $120 million. The new facility is expected

Exercise 9.1: Basic computations A company is considering investing in a new production facility at a cost of $120 million. The new facility is expected to produce annual cost savings as set out in Table 9.21. The facility is expected to have a useful life of eight years, before becoming obsolete and requiring replacement. The company has a policy of depreciating all assets on a straight-line basis.

Table 9.21 Year Annual cost savings 1 $30m 2 $35m 3 $40m 4 $45m 5 $30m 6 $26m 7 $15m 8 $15m Required:

Evaluate the investment using the following techniques:

(a) Payback period – the company considers a capital investment to be acceptable if it pays back within four years. Should the company make the investment?

(b) ARR – what is the accounting rate of return on the average capital employed?

(c) NPV – if the capital investment has a required rate of return of 12 per cent, what is its net present value? Should the company make the investment?

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