QUESTION 4 (25 Marks)

REQUIRED

4.1 Calculate the Payback Period of Machine A (expressed in years, months and days). (3 marks)

4.2 Calculate the Net Present Value of both machines. (8 marks)

4.3 Calculate the Accounting Rate of Return on initial investment (expressed to two decimal places) of both machines. (8 marks)

4.4 Calculate the Internal Rate of Return of Machine B (expressed to two decimal places). (5 marks)

4.5 If the time value of money is taken into account, which machine should be chosen? Why? (1 mark)

INFORMATION The directors of Lomax Ltd intend expanding the company and they have the choice of purchasing one of two machines at the end of 2022 viz. Machine A or Machine B. Both machines have a five-year life, with only Machine A having a residual value of R300 000. The annual volume of production of each machine is estimated at 6 000 pallets (comprising 500 bricks each), which can be sold at R520 per pallet. Depreciation is calculated on the machines using the straight-line method.

Machine A costs R4 800 000 excluding installation cost of R300 000. The annual variable costs are estimated at R1 100 000. A major overhaul at a cost of R200 000 is expected to be undertaken at the end of year three. Fixed costs are estimated at R500 000 (excluding depreciation).

Machine B costs R5 100 000 including installation costs of R400 000. Its annual variable costs are estimated at R1 050 000. Fixed costs are the same as for Machine A.

The cost of capital may be assumed to be 14%.