Flamingo Inn has outsourced its laundry service to a contract cleaning company at an annual cost of $360,000. Now, due to escalating costs, Flamingo is considering performing the service itself by purchasing new washers, dryers, and presses at a total cost of 500,000. Compared to outsourcing, the Financial Controller expects average cash savings of $150,000 per year. The machines are expected to last for 5 years with no residual value. The desired rate of return is 10% for this project.

Given:

Present Value of an Annuity $1 per Period:

Given:

Present Value of an Annuity $1 per Period:

Periods 10% 1 0.9091 2 1.7355 3 2.4869 4 3.1699 5 3.7908 6 4.3553 7 4.8684 8 5.3349 9 5.7590

To evaluate whether to undertake any capital budgeting project proposal, the company only carry out those projects that can get back its investment capital within 2 years.

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Question A1 (continued)

Required:

1. (a) Compute the payback period for the project and explain (within 10 words) whether it is acceptable or not. (3 marks)

2. (b) Compute the NPV of the project and explain (within 10 words) whether the project is acceptable or not. (3 marks)

3. (c) Consider the following scenarios separately by using NPV analysis:

   (i) Suppose the machines can only last for 4 years. Is this project acceptable and why (within 10 words)? (3 marks)

   2. (ii) Suppose, due to environmental health regulations, Flamingo has to spend an additional $10,000 cash to dispose all machines at the end of the year five. Is this project acceptable and why (within 10 words)? (3 marks)

   3. (iii) Based on an expected machines useful life of 5 years, what is the minimum annual cash savings required in order to justify the investment of this project? (3 marks)

4. (d) In making capital budgeting decisions, why do we focus on cash flows rather than accounting profits? (within 80 words) (4 marks)