Problem:
A hospital is considering the purchase of new equipment. - Machine A and Machine B.
Machine A:
Has a cost of $100000 and has an expected economic life of five years, after which it has a scrap value: $ 25000. The after taz profits or losses for the next five years are ($10,200), $10000, $30000, $20000 and $15000.
Machine B
Has an initial cash outlay of $105000 with an economic life of five years and no scrap value. The annual after tax profits are expected to be $14000 for each of the next five years.
The hospital requires a return on average assets employed of 18 % and has a cost of capital of 12%. Its also prefers projects that pay for themselves within three years.
Depreciation is always on a straight line basis.
1. Calculate:
The ARR
The PP
The NPV
The IRR
2. Which machine is better investment and why?
3. Explain your preferred method of evaluating the investment merits of these machines.
4. Why cash flows rather than profit flow that used in the IRR, NPV and PP method of investment appraisal?
5. Why opportunity cost is important in capital investment decision?