Anston Industries is the manufacturing division of a large multinational. The divisional general manager is about to purchase new equipment for the manufacture of a new product. He can buy either the Compax or the Newpax equipment, each of which has the same capacity and an expected life of four years. Depreciation, the only non-cash expense, is expensed at an equal rate each year, with no salvage value. Each type of equipment has different capital costs and expected cash flows, as follows:

The equipment will be installed and paid for at the end of the current year (Year 0) and the cash flows accrue at the end of each year. There is no scrap value for either piece of equipment. In calculating divisional returns, divisional assets are valued at net book value at the beginning of each year.
The multinational expects each division to achieve a minimum return before tax of 16%.
Anston is just managing to achieve that target. Anything less than a 16% return would make the divisional general manager ineligible for his profit-sharing bonus.

a. Prepare return on investment (ROI) and residual income (RI) calculations for Compax and the Newpax for each year.

b. Suggest which equipment is preferred under each method.

c. Compare this with the NPV calculation.

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Compax Initial capital investment $6,400,000 Newpax $5,200,000 Net cash inflows (before tax) Year I $2,400,000 $2,600,000 Year 2 2,400,000 2,200,000 Year 3 2,400,000 1,500,000 Year 4 2,400,000 1,000,000 Net present value (at 16% per year) $315,634 $189,615