Case study
Ms. Pamela Miner is the owner of an expanding business operating in fast food industry located in Bridgetown, Barbados. Over the last few years, business has been great. However, she believes it is time to grow and be more profitable. As such, Ms. Miner has decided to invest in a new sophisticated convection oven that would boost production levels by 125% in a more efficient manner. As an astute assistant manager to Ms. Miner, he asked you analyze the following variables to assist in informing the correct decision:
1. Ms. Miner is considering investing in one of two convection ovens - Type X102 and
Type Y112;
2. The initial investment costs of ovens Type X102 and Type Y112 are both $105,000 each;
3. Over a 5-year period directly following the investment, projected revenue attributed to the Type X102 oven is $67,000 a year. While projected expenditure is $35,000 a year for the Type X102 oven;
4. This is not the same for the Type Y112 oven investment, which is projected to only have revenue and expenditure of $280,000 and $105,000 respectively in the fifth year;
5. The situation that surrounds the current oven (old) is that if it sold/traded-in under the Type X102 oven investment arrangement then Ms. Miner will receive a $7,000 profit a year on such a sale over a 5 year period;
6. Conversely with the Type Y112 oven investment the current oven if sold/traded-in will yield a $30,000 profit at the end year 5;
7. Assume no tax is applied to the business;
8. The cost of capital for each investment is 11%.
You are required to: (SHOW ALL WORKINGS)
i. Using an example, briefly explain to Ms. Miner what is meant by mutually exclusive investments.
ii. Compute each investment's payback period.
iii. Compute each investment's Net Present Value (NPV).
iv. Compute each investment's Internal Rate of Return (IRR).
v. Which investment should Mr. Miner accept and why?
vi. Based on the above calculations and analysis, what has caused the ranking conflict?
vii. List two (2) advantages and one (1) disadvantage of using the NPV method in evaluating business investments.