QUESTIONS 401
13.4 Anston Industries is the manufacturing division of a large multinational.
The divisional general manager is about to purchase new equipment for the
manufacture of a new product. He can buy either the Compax or the Newpax
equipment, each of which has the same capacity and an expected life of four
years. Each type of equipment has different capital costs and expected cash flows,
as follows:
Compax Newpax
Initial capital investment 6,400,000 5,200,000
Net cash inflows (before tax)
Year 1 2,400,000 2,600,000
Year 2 2,400,000 2,200,000
Year 3 2,400,000 1,500,000
Year 4 2,400,000 1,000,000
Net present value (@ 16% p.a.) £315,634 £189,615The equipment will be installed and paid for at the end of the current year (Year 0)
and the cash flows accrue at the end of each year. There is no scrap value for either
piece of equipment. In calculating divisional returns, divisional assets are valued
at net book value at the beginning of each year.
The multinational expects each division to achieve a minimum return before
tax of 16%. Anston is just managing to achieve that target. Anything less than
a 16% return would make the divisional general manager ineligible for his
profit-sharing bonus.
žPrepare return on investment (ROI) and residual income (RI) calculations for
the Compax and the Newpax for each year.
žSuggest which equipment is preferred under each method.
žCompare this with the NPV calculation.
13.5 Magna Products PLC has three divisions, A, B and C. The current invest-
ments in and net profits earned by each division are as follows:
Division A
Investment £1,000,000
Net profit £75,000
Division B
Investment £1,500,000
Net profit £90,000
Division C
Investment £2,000,000
Net profit £150,000Each division has put forward to the parent board a capital expenditure proposal
for £50,000. Each division expects to produce net profits of £40,000 from that
investment. Magna’s cost of capital is 7% p.a.