Investment Appraisal

March 2021

Dr Philip E Dunn tests your knowledge of investment appraisal.

Philip Stentiford is an agricultural contractor based in North Yorkshire. He is considering investing £120,000 in one of two machines.

The forecasted cash flow from these over a five-year period is listed below:

Machine (A) Yr1 £40,000 Yr2 £50,000 Yr3 £30,000 Yr4 £45,000 and Yr 5 £25,000

Machine (B) Yr1 £25,000 Yr2 £35,000 Yr3 £50,000 Yr4 £40,000 and Yr5 £25,000

The business has a cost of capital of 12% and discounts projects at that rate.

NPV Factors at 12% Yr1 0.893 Yr2 0.797 Yr3 0.712 Yr4 0.636 and Yr 5 0.567

Q1: Calculate the Net Present Value of Machine (A).

Q2: Calculate the Net Present Value of Machine (B).

Q3: Calculate the Discounted Payback Index/ Profitability Index for Machine (A).

Q4: Calculate the Discounted Payback Index/ Profitability Index for Machine (B).

Q5: Calculate the Discounted Payback Period for Machine (A).

Q6: Calculate the Discounted Payback Period for Machine (B).

Q7: Management need to know what Discounted Cash Flow Rate the machine with the higher NPV is achieving.

Discount the machine showing the higher Net Present Value at 20% and calculate its Net
Present Value.

NPV Factors at 20% Yr1 0.833 Yr2 0.694 Yr3 0.579 Yr4 0.482 and Yr5 0.402

Q8: Calculate the Internal Rate of Return (IRR) for the machine relevant to Q7.

Management suggest that if the second machine could achieve an Internal Rate of Return of 16% they may invest in both machines.

Q9: Calculate the Net Present Value of your second choice machine using a rate of 20%.

Q10: Calculate the Internal Rate of Return of the machine relevant to Q9.

Q11: Bearing in mind your answer to Q10, is it likely that the management would invest in both machines?

• Dr Philip E Dunn is a freelance author and technical editor for Kaplan and Osborne Books