1. Harrybecca plc is currently planning on investing in a new machine which will cost £1.5m to purchase. The machine will be used for 4 years, after which time, it will be sold for scrap for £300,000. Also, an initial one-off investment in working capital of £200,000 will also be required. The machine qualifies for capital allowances on a 25% reducing balance basis.

It is expected the new machine will generate new cash sales of £900,000 of per year (at current prices). The expected annual inflation rate of sales price is estimated to be 5%. The associated annual variable costs are estimated to be £275,000 (also at current prices) and have an associated inflation rate of 3%.

The fixed costs (in money terms) are estimated as follows:

Year	1	2	3	4
Fixed costs	£150,000	£175,000	£185,000	£195,000

           

Harrybecca plc uses a discount rate of 10% in the investment appraisal process and pays corporation tax at 19%, paid one year in arrears.

Required:

Calculate the net present value (NPV) of the proposed machine purchase and advise Harrybecca plc whether it should purchase the machine or not.

(15 marks)

2. Calculate the IRR for the project above. Does the result provide the company with any additional information in terms of helping them come to a decision?

(6 marks)

3. Explain the significance of the reinvestment decision for NPV and IRR.