Flora owns and operates Flora’s Fizzy, which sells lemon flavoured carbonated drink. Flora has experienced a few problems with reliably sourcing the lemon syrup for the drink, and she would like to purchase a machine that would squeeze and process the lemon syrup used for the carbonated drink from the lemons in her orchard. Flora’s grandfather frequently advises her on business matters, but is not convinced that the processing machinery will be more efficient and profitable than purchasing the syrup. He has suggested using capital budgeting to help with the investment decision. The new processing machinery requires a capital outlay of $150,000 and will have a residual value of $30,000 at the end of its five year useful life.

It is expected that the new processing machinery will generate the following Net Cash Inflow:

Year Net Cash Inflow
1 $40,000
2 36,000
3 32,000
4 32,000
5 32,000

Flora uses straight-line depreciation on all machinery.

Flora requires a minimum 13 per cent accounting rate of return and a four year payback period for any investment project. Flora’s cost of capital is 8 per cent.
Flora owns and operates Flora’s Fizzy, which sells lemon flavoured carbonated drink. Flora has experienced a few problems with reliably sourcing the lemon syrup for the drink, and she would like to purchase a machine that would squeeze and process the lemon syrup used for the carbonated drink from the lemons in her orchard. Flora’s grandfather frequently advises her on business matters, but is not convinced that the processing machinery will be more efficient and profitable than purchasing the syrup. He has suggested using capital budgeting to help with the investment decision.

The new processing machinery requires a capital outlay of $150,000 and will have a residual value of $30,000 at the end of its five year useful life.
It is expected that the new processing machinery will generate the following Net Cash Inflow:
Year Net Cash Inflow
1 $40,000
2 36,000
3 32,000
4 32,000
5 32,000

Flora uses straight-line depreciation on all machinery.

Flora requires a minimum 13 per cent accounting rate of return and a four year payback period for any investment project. Flora’s cost of capital is 8 per cent.

Required:
Use the background information above and any other information you believe necessary to answer the following questions. Show ALL workings. Ignore income tax in your calculations.

1. Identify, using examples, TWO (2) specific risks associated with investment in the proposed new processing machinery AND explain how these risks could impact the business. (8 marks)

2. Draw the cash flow time line for the investment in the proposed new processing machinery and indicate the cash flow patterns represented on the cash flow time line. (5 marks)

3. Calculate the annual depreciation expense for the proposed new processing machinery. (5 marks)
4. Calculate the average accounting rate of return (ARR) of the proposed new processing machinery. (10 marks)
5. Calculate the payback period (PP) of the proposed new processing machinery. (5 marks)
6. Calculate the net present value (NPV) of the proposed new processing machinery. (10 marks)
7. Compute the internal rate of return (IRR) of the proposed new processing machinery. (15 marks)
8. Given your answers to Questions 4-7, explain whether or not Flora should invest in the proposed new processing machinery on the basis of: (a) each individual investment appraisal technique (HINT: a table might be useful to answer this); and (b) overall. (8 marks)
9. Briefly discuss whether, and if so how, depreciation affects your calculations in Questions 4-7. (8 marks)
10. Identify, giving reasons, TWO (2) pieces of additional information that would aid Flora in deciding whether or not to invest in the new processing machinery.