a.Jane runs her own gift shop and is currently looking to open a second similar shop in a nearby town. It must have a payback on the original investment of not more than 4 years.

Jane has identified a new store which will require an initial investment of 691,200 and thereafter she anticipates that there should be cash inflows as follows:

Year One115,200

Year Two201,600

Year Three288,000

Year Four403,200

Year Five144,000

Question 1:

a.Jane runs her own gift shop and is currently looking to open a second similar shop in a nearby town. It must have a payback on the original investment of not more than 4 years.

Jane has identified a new store which will require an initial investment of 691,200 and thereafter she anticipates that there should be cash inflows as follows:

Year One115,200

Year Two201,600

Year Three288,000

Year Four403,200

Year Five144,000

Requirement

i.Using the payback method calculate whether this new store will be suitable for Jane

ii.Discuss the advantages and disadvantages of the payback method for investment appraisal

b.MarmajamCo, a manufacturer of preserves has won a contract to supply a large food retailer with a range of bottled preserves for the next three years.

To ensure that the company can fulfil the order, the management of Marmajam Co plan to buy a new machine.

The cost of the machine, payableimmediately,is 1,500,000 and Marmajam only intends to keep the machine for the threeyears of the project when it expects to sell it for 700,000.The machine will not be replaced.

Productionandsalesfromthenewmachineareexpectedtobe100,000 boxes of preserves peryear.Eachboxcanbesoldfor30perboxandwillincurvariablecostsof18perbox.

Incrementalfixedcostsarisingfromtheoperationofthemachine will be 350,000 peryear.

MarmajamCohasanafter-taxcostofcapitalof10%whichitusesasadiscountrateininvestmentappraisal.

The company pays profit tax one year in arrears at an annual rate of 30% per year.

Tax allowances would be available on the cost of the machine on a 25% reducing balance basis

Inflation should be ignored.

Requirement:

Calculatethenetpresentvalueofinvestinginthenewmachineandadvisewhethertheinvestmentis financially acceptable.

c.Explain the various methods available to companies for incorporating risk when evaluating projects.

Answer rating: 100% (QA)

a Question 1 Payback Method i To calculate the payback period we need to accumulate the cash inflows until they equal or exceed the initial investment ... View the full answer