QUESTION 1

Nu Line Electronics wants to invest in machinery to increase production capacity at its Mpumalanga plant. The following two alternatives are under consideration:

OPTION 1

Purchase machinery at a total cost of R1 200 000. This machinery will have a useful life of four years and will have a scrap value of R120 000 at the end of its useful life. This machinery will generate the following net cash inflows:

Year Net cash inflow R

1 420 000

2 480 000

3 510 000

4 540 000

OPTION 2

Purchase machinery at a total cost of R850 000. This machinery will have a five-year useful life after which it will be disposed of at NIL scrap value. The machinery will generate net cash inflows of R220 000 every year over the five years.

Nu Line Electronics depreciates all machinery on the straight line basis over its useful life. The required rate of return on any investment is 8%.

1.1 Calculate the payback period for both options. (answers in years and months). (4 marks)

1.2 Calculate the net present value for both options. (6 marks)

1.3 Calculate the profitability index for both options. (answers rounded to 2 decimal places). (2 marks)

1.4

Calculate the accounting rate of return on average investment for option 1. (answer rounded to 2 decimal places).

(6 marks)

1.5 Based on the net present values calculated, which machinery should be chosen. Provide a reason (2 marks)