## Investment appraisal - quantitative factors - numerical questions 2

#### Question 1

Wells Ltd is considering extending its operations into the production and sale of components used in the making of lawnmowers. The components cost \$7 to manufacture and would be sold on to the lawnmower manufacturer for \$12. A new machine will be needed costing \$10,000 which is payable on 1 January in Year 1.

The expected sales of these are as follows:

Units
Year 1 600
Year 2 650
Year 3 720
Year 4 800
Year 5 850

The cost of capital is 10%.

The following is an extract from the present value table for a cost of capital of 10%:

10%
Year 1 0.909
Year 2 0.826
Year 3 0.751
Year 4 0.683
Year 5 0.621

It is assumed that revenues are received and costs are paid off at the end of each year.

It is assumed that everything produced is sold

(a) Calculate the annual net cash flows for each year, which are expected to result from the purchase of the machine.
(b) Using the expected annual net cash flows, calculate the net present value for the machine.

#### Question 2

The assembly machine of Tahoulan Ltd could be replaced. The replacement machine will cost \$400,000, which is payable on 1 January in Year 1. The new machine will be able to assemble 24,000 units a year. However, this is expected to rise by 25% from the start of year 4.

The cost of capital is 10%.

• The following is an extract from the present value table for a cost of capital of 10%:
10%
Year 1 0.909
Year 2 0.826
Year 3 0.751
Year 4 0.683
Year 5 0.621

• It is assumed that revenues are received and costs are paid off at the end of each year.
• It is assumed that everything produced is sold
• Each unit of production costs \$25 to manufacture, but will rise to \$32 in year 3 and \$35 in year 4 onwards.
• Each unit is expected to sell for \$35 in years 1 and 2 rising by 10% (compound) in years 3 and 4, thereafter remaining constant.

Should the assembly machine be replaced?