Accounting Business Reporting for Decision Making

CHAPTER 12 Capital investment 525

d. What is the IRR for the venture?

e. Would you advise the producers to go ahead or not? Why?

12.27 Deciding between two machines   LO2, 5

Land Ltd is considering the purchase of one of two acceptable pieces of equipment. Each design is

expected to have individual advantages. The chief accountant is quite conservative and likes to rely

on the ARR as his chief decision-support tool. The assistant accountant, on the other hand, is a new

graduate and she has worked out the expected IRRs for the two items of plant as shown below.

Equipment A Equipment B

ARR (%) 40 35

IRR (%) 16 18

Required

a. What more financial information does the board need to make a decision?

b. Would you rely only on this information to make a decision? If not, why not?

c. If the calculated returns all exceed the entity’s required minimum rate, which design would

you recommend? Why?

12.28 Deciding on a new machine   LO4

A small industrial machine costs $124 000 and is expected to earn annual net cash inflows of

$54 600, $49 600, $44 600 and $39 700, before it wears out sufficiently to be unreliable and must

be sold for an estimated $12 400.

Required

a. If funds earn 11 per cent, what is its NPV?

b. If funds earn 15 per cent, what is its NPV?

c. What is the IRR for the machine?

d. Advise management on the purchase of the machine.

12.29 Deciding on a new machine   LO4, 5

Los Dangles Ltd is considering a new machine which will reduce net cash inflow by $40 000 in

the current year, but increase net cash inflow by $8000, $12 000, $16 000, $20 000, $24 000 and

$28 000 in the following six years.

Required

a. If Los Dangles’ cost of capital is 10 per cent, should it buy the machine?

b. If Los Dangles’ cost of capital is 20 per cent, should it buy the machine?

c. What is the IRR for the machine?

d. Advise management on the purchase of the machine.

12.30 Deciding on improving a process   LO4

An improvement to the process in a men’s shirt factory will cost $1.5 million but will result in

net cost savings of $450 000 annually for the next ten years.

Required

a. If funds are worth 10 per cent, what is the NPV for the investment?

b. If the shirt factory process improvements turn out to cost $2 million, are the process changes

still worth making?

12.31 Deciding on a new venture    LO3, 4, 5

Ben Wong wants to buy a taxi plate in the inner Melbourne suburb of Richmond. Taxi regis-

tration plates (which confer the right to own and operate a taxi) are limited in supply and, hence,

cost a great deal. Ben finds a plate for sale at $510 000. A new vehicle fitted with radio, phone

and meter will cost $51 000. He reckons on driving the cab himself for up to 12 hours a day, and

maybe hiring a driver to drive it for another 6–8 hours each day. He thinks he can net $153 000

each year after all cash costs are paid. After five years of this high workload, he aims to sell the

cab and plate. To be conservative, he allows only $102 000 as the amount recouped.