Question 2 - Investment Appraisal Techniques

Newtake Limited, a fast-food company is considering purchasing a new storage machine for

588,300. The company is expecting an annual cash inflow of 223,600 from the sale of its

products and an annual cash outflow of 32,700 for each of the six years of the machines useful

life. The annual cash outflows do not include annual depreciation charges for the machine. The

machine is depreciated by using a straight-line method of the original cost of the machine. The

machine is expected to have a scrap value of 15% of the original cost of investment. The cost of

capital for Newtake Limited is 8%.

You are required to:

(a) Calculate (to two decimal places) using the following investment appraisal techniques,

and provide brief recommendations as to the economic feasibility of acquiring the machine:

i. The Payback Period.

ii. The Accounting Rate of Return.

iii. The Net Present Value.

iv. The Internal Rate of Return

(b) Alternatively, the financial director of Newtake Limited is proposing to use 40% the total

capital outlay for the above investment to repurchase some of the equity capital and the

remaining of the investment funds to pay for cash dividends. In contrast, Newtake management

are planning to issue a script dividend rather than a cash dividend. Ensuring the response

draws upon relevant academic research and theories within this highly topical area of financial

management, critically evaluate the effects of these proposals on the company.

.

(c) Critically discuss three proposed sources of finance for this project by considering relevant

factors as compared to a listed company.

(d)Critically evaluate the benefits and limitations of each of the differing investment appraisal

techniques, ensuring the use of relevant academic literature.