Reference no: EM133014391

Question - Meriton Ltd is considering expanding by buying a new (additional) machine that costs $92 000, has zero terminal disposal value and a five-year useful life. It expects the annual increase in cash revenues from the expansion to be $38 500 per year. It expects additional annual cash costs to be $12 000 per year. Its cost of capital is 8%. Ignore taxes.

Required -

1. Calculate the net present value and internal rate of return for this investment.

2. Assume that the finance manager of Meriton is not sure about the cash revenues and costs. The revenues could be anywhere from 15% higher to 15% lower than predicted. Assume cash costs are still $12 000 per year. What are the NPV and IRR at the high and low points for revenue?

3. The finance manager thinks that costs will vary with revenues, and if the revenues are 15% higher the costs will be 10% higher. If the revenues are 15% lower, the costs will be 10% lower. Recalculate the NPV and IRR at the high and low revenue points with this new cost information.

4. The finance manager has decided that the company should earn 4% more than the cost of capital on any project. Recalculate the original NPV in requirement 1 using the new discount rate and evaluate the investment opportunity.

5. Discuss how the changes in assumptions have affected the decision to expand. (Show all your calculations to the nearest whole number).