The management of Yogi Ltd are evaluating two investment options.

Option One is to purchase a large capacity production machine at a cost of 170,000. The additional net cash operating inflow due to this investment will be 72,000 in the first year, 75,000 in the second and 82,000 in the third year.

Due to the expertise required to operate this machine, they will need to hire a new specialist supervisor at a cost of 20,000 per year. They have included this cost in the above net operating cashflow.

Option Two is to purchase a lower capacity production machine at a cost of 110,000. The additional net cash operating inflow due to this investment will be 50,000 in the first year, 55,000 in the second year, and 60,000 in the third year.

The minimum desired rate of return for both investments is 10%. Both machines have no salvage value. Round all discount factors to three decimal places.

Required

• Explain whether management were right to include the supervisor cost in Option One as a relevant cost for this investment option (2 marks)
• Calculate the NPV for both investments (18 marks)
• Which one of the two options should Yogi Ltd choose and why (2 marks)?