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Case: Capital Investment Decision, Debt Financing and importance of Loan Covenants Lit Support Ltd is considering a project that requires the company to purchase several new photocopying machines. At the start of this project, the company will have to spend a considerable amount of money to acquire the necessary types of machinery and equipment and to initiate the new project. All these expenses constitute the cash outflows of the project. The project is then expected to generate a continuous stream of income in the form of service income. Let's assume that the project will generate income in the form of Service Fees paid by the users of the Lit Support project for 4 years. Fees paid by the users of the project will constitute the project's cash inflows. Therefore, the Company should only proceed with the project if the NPV is positive. In the beginning, the company requires an initial outflow of $136000 and is expected to generate net cash inflows over the next four years of $58200, $52600, $49500, and $42100 respectively. In addition, the machines are estimated to have a salvage value of $16300 at the end of year 4 before the machines wear out sufficiently. The given required rate of return is 15%.
Questions
Capital Budgeting Techniques
a. Explain the nature and scope of investment Decisions.
b. Describe the concept of the Accounting Rate of Return (ARR.
c. Explain the use of the Payback Period (PP).
d. Discuss the concept and decision rules of Net present value (NPV) and IRR. and the decision rules.
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