Calculate the NPV and ARR
The manager of XYZ Ltd has identified a market for a new product that she estimates can be sold for $12 per unit. Research indicates that the business could produce and sell 14 000 units each year for 5 years.
The business will need to purchase a new piece of machinery to manufacture the product and the following information has been prepared relating to this purchase:
Purchase cost of the machinery $100 000
Estimated scrap value of the machinery after 5 years $10 000
Operating costs $6 per unit produced
Operator's wage $28 000 per year
a. Calculate the net present value (NPV), the accounting rate of return (ARR) and the payback period for the project. A required rate of return of 12% is assumed when calculating the NPV of a project for this company.
b. Referring to your calculations in part a, explain how the manager of XYZ Ltd would decide whether to proceed with the project. Include in your answer a clear explanation of what the NPV, ARR and payback figures that you have calculated show.
c. Explain why capital investment decisions of the type described in this question are risky and difficult to make.
d. Describe how a manager might practically apply capital expenditure evaluation in a private or public sector organisation?