Question

Question 12 [10 marks]

Minton Limited intends purchasing a new machine and has the option of purchasing one of the

following two machines:

                                              Machine A                                       Machine B

Purchase price                        R400 000                                           R480 000

Expected economic lifetime        4 years                                              4 years

Scrap value                                     0                                                    0

Minimum required rate of return   12%                                                12%

Expected net cash inflows            R                                                          R

End of: Year 1                   120 000                                              170 000

Year 2                                    170 000                                                  170 000

Year 3                                    180 000                                               170 000

Year 4                                    200 000                                               170 000

Average annual profit         R67 500                                               R50 000

12.1)Calculate the Payback Period for Machine A. (Answers must be expressed in years

        and months)

12.2) Calculate the Accounting Rate of Return (on average investment) for Machine A .

12.3) Calculate the Net Present Value (NPV) of both machines

12.4) Based on the Net Present Value, which machine should Minton Limited purchase?   

       Explain why.

Answer 1

Details	Machine A	Machine B
Purchase price	400000	480000
Expected economic life (in years)	4	4
Scrap value	0	0
Minimum required rate of return	12%	12%
Expected net cashflows
Year 1	120000	170000
Year 2	170000	170000
Year 3	180000	170000
Year 4	200000	170000
Average annual profit	67500	50000

Part 12.1 - Computation of Payback period for Machine A

Details	Machine A
Investment (purchase price of machinery)	400000
Average annual profit	67500
Payback period ---> (Investment / average annual profit) in years	5.93
Converting the decimal or incomplete year into months by multiplying the decimal with 12 (12 months a year) ---> 0.93* 12 & 0.6*12 respectively	11.16
Payback period in years and months	5 years 11 months

Part 12.2 - Computation of Accounting rate of return

Computation of Average investment

Details	Machine A	Machine B
Book value of asset at Year 1	400000	480000
Book value of asset at end useful life	0	0
Average investment (Book value at year 1 + Book value at end of useful life) /2	200000	240000

Computation of Accounting rate of return

Details	Machine A	Machine B
Average annual profit	67500	50000
Average investment (from above table)	200000	240000
Accounting rate of return (Average annual profit / Average investment)	33.75%	20.83%

Part 12.2 - Computation of NPV

Machine A

Year	0	1	2	3	4
Initial cashflows
Investment	(400,000.00)
Intermediate cash flows
Expected cashflows		120,000.00	170,000.00	180,000.00	200,000.00
Terminal cashflows	-	-	-	-	-
Net cashflows (Initial + Intermediate + Terminal)	(400,000.00)	120,000.00	170,000.00	180,000.00	200,000.00
PV factor @ 12% (minimum rate of return) --- > (1/ (1+rate of return) ^year)	1.0000	0.8929	0.7972	0.7118	0.6355
Present value of cashflows (Net cashflows x PV factor)	(400,000.00)	107,142.86	135,522.96	128,120.44	127,103.62
Net Present value of cashflows	97,889.88

Unable provide complete answer