Felco Limited is going into the manufacture of a blue tooth device and has identified two potential machines that could be used to produce it. The Finance Manager has produced for the board the following potential cash flows from operating either machine. Year Machine Machine A B '000 '000 0 Capital Outlay -2800 -3600 1 Cash Inflow 800 900 2 Cash Inflow 800 900 3 Cash Inflow 800 900 4 Cash Inflow 800 900 5 Cash Inflow 800 900 5 Residual Value 400 600 The company has a cost of capital of 13% Required a) Calculate the Payback period for each of the machines and identify which should be invested in and explain why. 3 marks b) Calculate Accounting rate of Return for each machine and identify which should be invested in and explain why. 5 marks c) Calculate the Net present Value of each machine and identify which should be invested in and explain why. 6 marks

d) The Marketing Director believes that the production of this new generic drug is more risky and hence believes that the firm should not be discounting at the Cost of Capital but should add a 5% risk factor to it and discount at the Hurdle Rate of 18%. Recalculate the NPV for each product utilising this new hurdle rate and identify which should be invested in and explain why. 6 marks

Continued

e)

Critically evaluate each of the three methods i) Payback Method ii) Accounting Rate of Return iii) Net present Value Method 10 marks f)

As the Finance Manager, write a short memo to the Board to explain whether a hurdle rate should be used when undertaking the Net present value Computation

5 marks g) Based on your answers to part e and f, advise the board as to which machine should be invested in, fully justify your recommendation. 5 marks