Making capital investment decisions: Project 1

The directors of XYZ Ltd. are considering whether to invest in two separate projects: one is small while the other is large. The company has a cost of capital of 12% (hint: the discount rate).

Details of the two projects are set out below.

Project 1

The directors are considering buying a new machine, which should lead to cost savings. Two machines that are suitable for the business are on the market. These machines have the following outlays and expected cost savings:

Alpha machine Beta machine

Initial outlay

(15,000) (30,000)

Cost savings

1 year's time 6,000 8,000

2 years' time 10,000 11,000

3 years' time - 12,000

The business will have a continuing need for whichever machine is chosen.

Required:

1. Evaluate each machine using both theshortest-common-period-of-time approachand theequivalent-annual-annuityapproach. (All workings should be to two decimal places)

You need to show all your calculations in this question

2. Which machine would you recommend and why?