The Marsco Trading Company is contemplating investing in a machine costing $100,000 which has a life of ten years and no salvage value. It will require annual maintenance expenditure of $10,000 but will save labour costs totalling $25,000 p.a. Given that the company has traded with taxation losses for a number of years ignore the effects of taxation in this question. The newly appointed finance manager of the company, Ms. Barbie Joyce has come to see you for assistance as she has been asked by the companys board of directors to examine this proposal as a capital budgeting project. Barbie has recently obtained this position after a number of years in politics providing economic and accounting advice at a senior level to the government.

Required:

a) Provide a considered, informed response to the statement from Barbie below which confirms that the details provided in this question are indeed sufficient to commence analysis as a capital budgeting project: I am really confused - on what basis can the information provided for this proposal be considered as a capital budgeting project, given that the only actual cash flows arising are outflows? I thought there needs to be both inflows and outflows in order to undertake any useful calculations to assist the decision-making process?

b) Assuming all future cash flows occur at the end of each year, what rate of return can be expected from this machine? Include a time-diagram with your response to this part of the question.

c) Assuming all future cash flows occur at the beginning of each year, what rate of return would this machine return? Include a cash-flow / time-diagram with your solution to this problem.

d) Briefly discuss the reason for the difference in the returns (if any), calculated in your responses to sections b) and c) of this question.

e)

i) What is another name for the rate of return calculations above which, if used as the discount rate, would result in a zero net present value (NPV)?

ii) After calculating the rate of return (as discussed in part e) i) of this question), how would you know whether the project will result in the maximisation of shareholder wealth; 1. Where capital rationing exists, and 2. In the absence of capital rationing? Note: No further calculations are required for this part of the question.

iii) Briefly discuss some of the general limitations of this type of rate of return when used for the analysis of capital budgeting projects.