Question
Holden Ltd is a bubble-wrap manufacturing company that produces a number of bubble products such as bubble wraps and envelopes. The companys recently hired Managing
Holden Ltd is a bubble-wrap manufacturing company that produces a number of bubble products such as bubble wraps and envelopes. The companys recently hired Managing Director, Mr Green is leading on environmental initiatives in a bid to reduce energy consumption and, thus, the carbon emissions associated with production.
Mr Green has asked you, the Finance Manager, to replace the current machinery with a more sustainable and environmentally friendly one. Your team has proposed two machines for you to choose from that use cutting-edge technology to produce the current products in a more environmentally friendly way. The team has supplied the following information for you.
Table 2 Net cash flows for new machinery options
Project net cash flows () | ||
---|---|---|
Machine A | Machine B | |
Year 0 | (1,500,000) | (2,200,000) |
Year 1 | 740,000 | 670,000 |
Year 2 | 570,000 | 700,000 |
Year 3 | 480,000 | 830,000 |
Year 4 | 420,000 | 900,000 |
Year 5 | 360,000 | 1,070,000 |
Holden Ltd uses the straight-line method of depreciation and its cost of capital (i.e. the discount rate) is 15%. It is assumed that Machine A will have a residual value of 30,000 at the end of the five years, while Machine B will have a residual value of 50,000 at the end of the five years.
The companys policy for new investments is that the investment should pay itself back within three years.
- a.Calculate the payback period and net present value (NPV) of the proposed two machines. You are required to show all your workings to support your answers. (14 marks)
- b.Advise Mr Green on which machine the company should invest in based on your calculations in part (a) and provide a detailed explanation of your advice. (10 marks)
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