Olourun Ltd is the major employer in the Front Hill area, where the firm is located. The

company is considering the acquisition of a new production line. The equipment would cost

$720 000 and installation cost would amount to $59 000. At the end of its 5-year life, it is

expected to be disposed of at its salvage value of $70 000. The new equipment would allow the

company to expand production significantly, which would require an increase in working capital

of $90 000. If the purchase is made, the firm's maintenance costs would be reduced by $60 000

annually. However, at the end of the third year, a major overhaul would have to be undertaken at

a cost of $80 000. Operating cash flows would be $220 000 in the first year; this would increase

by 2% for each of the following years.

The company's cost of capital is 14% and the relevant corporate tax rate is 25%

a) Calculate the relevant after-tax net cash flows and after-tax profits over the life of the

investment. [10 marks]

b) Compute the project's ARR [5 marks]

c) What is the payback period? [5 marks]

d) Using the NPV as the basis of your decision, advise Olourun as to whether the company

should purchase the equipment. [7 marks]

e) Would you advise the company to base their decision on the payback method rather than

the NPV as used above? [5 marks]

f) Compute the IRR of the project [12 marks]

g) The company is considering another investment which would have an initial cost of

$800 000 and an NPV of $65000. There is a situation of capital rationing, and you have

suggested that the firm should use the profitability index to choose which investment to

implement. Advise the company. [7 marks]

h) Discuss THREE non-financial factors which the firm should consider when making this

decision. [9 marks]

i) Why is it important for the company to know its cost of capital when making investment

decisions?