Question
Capital Investment Ltd is considering an investment in an expansion of the company's product line. The accountant has just conducted a capital budgeting analysis estimating
Capital Investment Ltd is considering an investment in an expansion of the company's product line. The accountant has just conducted a capital budgeting analysis estimating an initial investment of $240,000 required to initiate the project at the beginning of Year 1.
Estimated net cash inflows generated from the new product line over the project life of 4 years are summarised in the following table; assuming that the cash flows will be received in lump sum at the end of each year.
Year Net Cash Inflows
1 $90,000
2 $80,000
3 $ 70,000
4 $60,000
Salvage value of machinery and equipment at the end of the product line's life is expected to be $50,000. The company uses the straight-line method as its depreciation policy.
The cost of capital applicable to the company in making investment decisions based on capital budgeting analysis is 10%. For the purpose of simplicity and consistency, income taxes are ignored and all figures are rounded to the nearest $1.
Required:
For the purpose of discussions in the next board meeting, the finance director has requested you to evaluate the attractiveness of the investment by providing calculations of the following project indicators (all figures are rounded to the nearest $1):
(a)Net present value (NPV)
(b)Profitability index (PI)
(c)Payback period (PBP)
(d)Accounting rate of return (ARR) based on initial investment
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