Self-test Fred Ltd manufacturers sports blazers. The company has over the past 2 years shown declining profits and the directors have decided that major capital investment is needed in the business if it is to succeed in the future.

A modern finishing machine which will improve the cut and finish of the blazers can be bought at a total cost, including installation charges, of £400,000.

As this is a highly specialised machine, the full amount would be due and payable on 1 January 2011.

At present the company produces and sells 20,000 blazers p.a. Research into the new machine convinces the directors that a higher production than their present one is possible. The production manager produces the following data showing the additional output of blazers resulting from the new machine:

Year Blazer units 2011 2,500 2012 3,400 2013 3,900 The cash flow is to be based on the information given by the production manager and also to take into account the fact that all production can be sold without any difficulty.

You are given the following additional information:

2011 2012 2013 Cost of sale £80 £87 £96 Selling price £146 £164 £180 Finance is available to the company at 10 per cent p.a.

The following table gives the present values for £1 at 10 per cent.

Year 1 0.909 Year 2 0.826 Year 3 0.751 Required:

(a) You are required to calculate the net cash flows for the years 2011, 2012 and 2013.

(b) You are also required to calculate the net present value for the purchase of the machine.

(c) Describe each of the following investment appraisal methods:
(i) payback period;
(ii) accounting rate of return.

(d) Evaluate whether Fred Limited should purchase the machine.

(e) State how the net present value could be used to find the internal rate of return of purchasing the cutting machine.

(f) Why would the internal rate of return be more valuable to Fred Limited than the net present value?