Alpha Ltd is considering the purchase a new machine, the details of the machines
from which it is to select one are as follows:
Machine I Machine II
Estimated Life 3 years 3 years
Capital Cost Rs. 90,000 Rs. 90,000
Earnings (after tax) Year 1 40,000 20,000
Year 2 50,000 70,000
Year 3 40,000 50,000
The company follows the straightline method of depreciation, the estimated salvage
value of both the types of machines is zero. You are to advise which is the most
profitable investment based on (i) Pay back period (ii) Accounting Rate of Return
and (iii) Net Present Value assuming a 10% cost of capital.
Answers
Answer:
Years Machine I Add back Dep Net Cash Flow
1. 40000. 30000 70000
2. 50000 30000 80000
3. 40000 30000 70000
Years Machine II Add back Dep Net Cash Flow
1. 20000. 30000 50000
2. 70000 30000 100000
3. 50000 30000 80000
Years Net Cash Flow. PVF Present Value
Machine I Machine II Mach I. Mach II
1. 70000. 50000. .909 63630. 45450
2. 80000 100000. .826. 66080. 82600
3. 70000 80000. .752 52640. 60160
Total Present Value. = 182350 188210
Less : Initial investment = 90000. 90000
Net Present Value =. 92350. 98210
Since NPV of Machine II is greater than Machine I so Machine II is preferable.
Average Cash Flows
Machine I
63630 + 66080 + 52640 = 60783.
3
Average Rate of Return = 60783 * 100 = 67. 53%
90000
Machine II
45450 + 82600 + 60160 = 62736.
3
Average Rate of Return = 62736 * 100 = 69. 71%
90000
Again ARR of Machine II is greater than Machine I therefore Machine II is preferable.
Present Value. Cumulative PV
Year Machine I Machine II Mach I. Mach II
1 63630. 45450 63630 45450
2. 66080. 82600. 129710. 128050
3. 52640. 60160. 182350 188210
Payback period
Machine I. = 1 + (90000 - 63630) = 1 +. 4 = 1.4
129720 - 63630
Machine II= 1 + (90000 - 45450) = 1 +. 54 = 1.54
128050 - 45450
As per payback Machine I is preferable
Please give brainliest to this solution