City Worx Limited wishes to determine the relevant operating cash flows associated with the proposed purchase of a new piece of equipment having an installed cost of K100 million and being depreciated at the rate of 14% reducing balance. The firms financial analyst has estimated that the relevant time horizon for analysis is 7 years. She expects the revenues attributable to the equipment to be K158 million in the first year and to increase at rate of 5% per year through to year 7. Similarly, she estimates all expenses other than depreciation attributable to the equipment to total K122 million in the first year and to increase by 4% per year through year 7. She plans to ignore any cash flows after year 7. The Asset has a disposable value of K5M at the end of the period. The firm has a marginal tax rate of 35% and its required return on the equipment investment is 12%.

REQUIRED

a) Find the relevant incremental cash flows for years 1 through to 7.

b) Calculate the simple Payback period

c) Using the cash flows found in part (a), determine the NPV, ARR, PI and IRR for the proposed equipment purchase.

d) Based on your NPV in part b, would you recommend that City Worx Limited Purchase the equipment? Why?