Question - Skyline Walkways Ltd is planning a project that is expected to last for 8 years. The project requires a large piece of machinery to be purchased at a cost of $320,000, with a residual value of $14,000 at the end of the project. The project is expected to generate an annual net cash inflow of $85,000 per year. In addition to its annual operating costs, the machinery will require a major overhaul at the end of year 5 which is expected to cost $90,000. The company has a minimum desired rate of return of 15% on all project. The company accountant prepared the following analysis to present to the board which indicated that this project should be rejected, as it does not meet the company's desired rate of return:
Annual net cash flow $85,000
Less:
Annual depreciation $38,250
Annual average cost of overhaul $11,250
Average annual net profit $35,500
Return on investment $35,500 / $320,000 = 11.1%
I. Critically assess the accountant's evaluation of the project.
II. Use cash flow analysis to demine whether the project should be accepted. Ignore tax effects.
III. Is the internal rate of return greater or less than 15%?