Seminar Question

A company is considering a capital investment proposal where two alternatives involving differing degrees of

mechanisation, are being considered. Both investments would have a five$-$year life. In Option $1$ new

machinery would cost $278,000,$ and in Option $2805,000.$ Anticipated scrap values after $5$ years are

$28,000$ and $150,000$ respectively. Depreciation is provided on a straight line basis. Option $1$ would

generate annual cash inflows of $100,000,$ and Option $2,250,000.$ The cost of capital is $15\%.$

Required:

$($a$)$ Calculate for each option:

$($i$)$ the payback period

$($ii$)$ the accounting rate of return, based on average book value

$($iii$)$ the net present value

$($iv$)$ the internal rate of return.

$($b$)$ Identify the preferred option, giving reasons for your choice.