5 Bramhope Manufacturing Co. Ltd has found that, after only two years of using a machine for a semi-automatic process, a more advanced model has arrived on the market. This advanced model will not only produce the current volume of the company’s product more efficiently, but allow increased output of the product. The existing machine had cost £32,000 and was being depreciated straight-line over a ten-year period, at the end of which it would be scrapped. The market value of this machine is currently £15,000 and there is a prospective purchaser interested in acquiring it.

The advanced model now available costs £123,500 fully installed. Because of its more complex mechanism, the advanced model is expected to have a useful life of only eight years. A scrap value of £20,500 is considered reasonable.

A comparison of the existing and advanced model now available shows the following:

The required return is 15 per cent.
(i) You are required to calculate:

(a) payback period

(b) the net present value

(c) the internal rate of return (to the nearest per cent)
(ii) What recommendation would you make to the sales director? What other considerations are relevant?

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Existing machine Advanced model Capacity p.a. Selling price per unit 200,000 units 230,000 units 0.95 0.95 Production costs per unit Labour 0.12 0.08 Materials 0.48 0.46 Fixed overheads (allocation of 0.25 0.16 portion of company's fixed overheads)