Question
The Flinders Island Airways Pty Ltd is planning a project which is expected to last for six years. During that time, the project is expected
The Flinders Island Airways Pty Ltd is planning a project which is expected to last for six years. During that time, the project is expected to generate net cash inflows of $75,000 per annum. The project will require the purchase of a machine for $280,000. This new machine is expected to have a salvage value of $10,000 at the end of six years. In addition to its annual operating costs, the machine will require an overhaul costing $50,000 at the end of the fourth year. The company presently has a minimum desired rate of return of 12 per cent. Based on this information, the accountant prepared the following analysis: Annual net cash inflow $75,000 Less: Annual depreciation. $45,000 Annual average cost of overhaul $8,333 $53,333 Average annual net profit $21,667 Return on investment: $21,667 / $280,000 = 7.7% Therefore, the accountant recommends that the project be rejected, as it does not meet the companys minimum desired rate of return. Required a. What criticism(s) would you make of the accountants evaluation of the project? b. Use cash flow analysis to determine whether or not the project should be accepted. c. Is the internal rate of return (IRR) greater or less than 12 per cent?
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