Problem: The company is considering investing in a machine costing $100,000. It has a 10 year life span, and no salvage value. Annual maintenance costs are $10,000pa, and labour savings are $25,000pa.
Ignore tax effects.
a. If all cash flows occur at the end of each year, what rate of return can be expected?
b. If all cash flows occur at the beginning of each year, what rate of return can be expected?
c.Why is there a difference (if any)?
d. What is another name forthis rate of return which, used as a discount rate, would result in a zero NPV?
e. After calculating this rate of return, how would you know whether this project will result in the maximisation of shareholder wealth?
f. Discuss the limitations of this type of rate of return, when used for the analysis of capital budgeting projects.