Case Study "Ausma Company" Ausma Co is a profitable Latvian company. After securing an extension to an existing contract, the directors of Ausma Co are reviewing the scenarios relating to an equipment that is a key part of the company's production process. Investment scenario 1 - To replace the equipment. The cost of a new equipment would be 450,000 , payable immediately. Maintenance costs would be payable at the end of each year of the project. The first maintenance payment for the new machine is 25,000 although this is expected to rise by 7.5% per year. Investment scenario 2 - To overhaul the existing equipment. (kapitlais remonts) The alternative to replacement is complete overhaul of an existing equipment, the cost of which would be 275,000 , also payable immediately. This would be classified as capital expenditure. However, under this scenario, the annual maintenance costs will be higher at 40,000 in year 1 with expected annual increases of 10.5%. As the new equipment is likely to reduce the variable cost, the contribution will be different depending on which equipment is used. The contribution from each equipment (excluding maintenance costs) is tabulated as follows, with the inflow of funds assumed to be at the end of each year:

Contribution with new equipment

Year 1. 150,000

Year 2. 170,000

Year 3 190,000

Year 4 210,000

Year 5 220,000

Contribution with overhauled equipment,

Year 1. 130,000

Year 2. 145,000

Year 3 155,000

Year 4 160,000

Year 5 160,000

The financial manager is unsure of the cost of capital, but expects it is around 12%. Taxation can be ignored.

Required:

1. Calculate the net present value of each scenario:

1.1. NPV for investment scenario 1?

1.2. NPV for investment scenario 2?

2. Calculate or estimate the internal rate of return of each scenario:

2.1. internal rate of return for investment scenario 1?

2.2. internal rate of return for investment scenario 2?