Supreme Computers Limited has been selling one of its computer parts, the ZTC for the past two years. The company needs to boost production capacity in order to meet increasing demand for the products.

A new production machine, with a useful life of four years and a maximum output of 600,000 units of Model ZTC per year, could be bought for 600,000, however, this would have to be paid immediately. The selling price of the machine at the end of its four-year life would be 30,000. Forecast demand and production of ZTC over the next four years is as follows:

Year 1 2 3 4

Demand (units) 13 million 14 million 15 million 16 million

Existing production capacity for ZTC is limited to one million units per year and the new machine would only be used for demand additional to this.

The current selling price of HCT is 800 per unit and the variable cost of materials is 500 per unit.

Other variable costs of production are 190 per unit. Fixed costs of production associated with the new machine would be 240,000 in the first year of production, increasing by 20,000 per year in each subsequent year of operation.

Supreme Computers uses its average cost of capital when appraising investment projects which is 10%. Relevant discount rates are as follows:

Years10%20%

10.90910.8333

20.82640.6944

30.75130.5787

40.68300.4823

REQUIRED:

(a)You are required to calculate the Net Present Value ("NPV") of buying the new machine and advise with reasons whether or not you believe that it represents a good investment by the Company based purely on the NPV result.

(b)Calculate the Internal Rate of Return ("IRR") of buying the new machine and advise with reasons whether or not you believe that it represents a good investment by the Company based purely on the IRR result.

(c)Critically explain how you can quantify risk in the context of investment appraisal.