The directors of Sunny Ltd. are considering automating part of the production process. Senior management has conducted a feasibility study at a cost of 8,000. Currently, the company is examining two capital investment projects for the purchase of new equipment.

Project A: a new machine would be needed for the process, at a cost of 180,000. It is expected to have a useful economic life of 4 years and a scrap value of 10,000 at the end of that time. Annual savings are expected to be 60,000. The firm treats savings in the same way as it treats revenues in its investment appraisal process.

Project B: an initial cash outlay of 60,000 is required. It is assumed that this machine will have a zero-scrap value. The net cash inflows of this project have been estimated as follows:

Project B Year One 20,000 Year Two 20,000 Year Three 20,000 Year Four 20,000 Year Five 20,000 Required: a. Work out the NPV of each project if the companys cost of capital is 10%. Identify which project should be selected if only one project can be chosen. Show all workings clearly.

b. State the formula used to calculate the accounting rate of return (ARR) and compute its value for each project (assuming straight line depreciation). Show all workings clearly.

c. Discuss the strengths and limitations of the ARR method.