Question

Bobsco Ltd is considering the acquisition of a new machine for £160,000. Bobsco Ltd's production manager estimates that the new machine maintenance costs is £12,000per year, payable at the end

of each year of operation. The maintenance costs is expected to increase by 15% per year. Sales will be £50,000 in the first year and expected to increase by 20% per year for two years and 40% for the fourth year. The views of the directors of Bobsco Ltd are that all investment projects are to be evaluated over four years of operations, with an assumed terminal value at the end of the fourth year of £11,000. Bobsco Ltd expects a maximum payback period of two years. The discount rate for the project is 12%. a. What is the payback period for this project? b. What is the NPV for this project? c. What is the IRR for this project? d. Comment on the financial acceptability of the proposed investment based on the three appraisal methods used. e. The company set the maximum payback period at 2 years. Discuss the possible reasons that necessitate the company to have such a low benchmark payback period? f. Discuss FOUR reasons why NPV is regarded as superior to IRR as an investment appraisal technique.

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