Reference no: EM133266454

This is an investment in new machinery to produce a recently-developed product. The cost of the machinery, which is payable immediately, is $1.5 million, and the scrap value of the machinery at the end of four years is expected to be $100,000. Capital allowances (tax-allowable depreciation) can be claimed on this investment on a 25% reducing balance basis. Information on future returns from the investment has been forecast to be as follows:

Year                                                 1                2                3                        4 

Sales volume (units/year)       50,000   95,000    140,000              75,000

Selling price ($/unit)         26.00           25.96           25.87                  26.91 

Variable cost ($/unit)               10.25           11.56           12.92                  13.80 

Fixed costs ($/year)         105,000       115,000       125,000              125,000 

Selling price per unit, variable cost per unit and fixed costs which are wholly attributable to the project, have already been adjusted for inflation. Ridag Co pays profit tax of 30% per year one year in arrears. Ridag uses an after-tax discount rate (cost of capital) of 7% when appraising the new investment

Required:

a) Net cash flows from year 1 to year 4

b) Payback period of the proposed investment

c) The accounting rate of return of the proposed investment

d) The net present value of the proposed investment

e) Discuss the reason why the net present value investment appraisal method is preferred to other investment appraisal methods such as payback, accounting rate of return and internal rate of return