Jaunty Ltd manufactures and sells fridges. The company is deciding whether to replace an existing manufacturing plant which it uses to produce fridges.
The old machine can be used for 5 more years and would generate cash inflows of $4,000 per year. It would cost Jaunty Ltd $1,500 in wages per year and $500 electricty per year to run the machine. Alternatively, it can be sold now for $10,000 which is its carrying amount recorded in the books (there is no gain or loss).
The new machine would cost $145,000 as a one off cash payment. Because of its increased efficiency, the new machine would generate cash inflows of $32,000 per year for the next 5 years and would cost $3000 in wages per year and $500 electricity per year. These are not incremental cash flows. After 5 years of operation it can be sold for $5000.
Jaunty requires a 10% return on similar investments.
Ignore depreciation and taxes for this question.
a) Draw a timeline showing the cash inflows and outflows relating to this investment. You may use Excel tools to do this or use another program such as MS Paint and then copy paste your image into the space provided.
b) Calculate the NPV of purchasing the new machine. Use the space provided. You can use any approach you like (i.e. by using an Excel function or by just showing the calculation).
c) Calculate the IRR of this project. Use the IRR Excel function to complete this task. You will have to do a bit of research on how to do this. Try this website but please ignore step 6:
d) What is the payback period of this project?
e) Should Jaunty accept or reject the project? Explain why.
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