Haverhill Engineers Ltd manufactures components for the car industry. It is considering automating its line for producing crankshaft bearings. The automated equipment will cost £700,000.

It will replace equipment with a scrap value of £50,000 and a book written-down value of

£180,000.

At present, the line has a capacity of 1.25 million units per year but typically it has only been run at 80 per cent of capacity because of the lack of demand for its output. The new line has a capacity of 1.4 million units per year. Its life is expected to be five years and its scrap value at that time £100,000.
The accountant has prepared the following cost estimates based on the expected output of 1,000,000 units per year:
New line (per unit) Old line (per unit)
pence pence Materials 40 36 Labour 22 10 Variable overheads 14 14 Fixed overheads 44 20 120 80 Selling price 150 150 Profit per unit 30 70 Fixed overheads include depreciation on the old machine of £40,000 per year and £120,000 for the new machine. It is considered that, for the business overall, fixed overheads are unlikely to change.
The introduction of the new machine will enable inventories to be reduced by £160,000. The business uses 10 per cent as its cost of capital. You should ignore taxation.
Required:

(a) Prepare a statement of the incremental cash flows arising from the project.

(b) Calculate the project’s net present value.

(c) Calculate the project’s approximate internal rate of return.

(d) Explain the terms net present value and internal rate of return. State which method you consider to be preferable, giving reasons for your choice.