Assignment 2 continued

Background Information:

Beatrice owns and operates Buzz Bizz, which processes and sells honey. Beatrices honey production

is limited by her current machinery, and has seen a new honey extractor using new technology that

will let her expand production. Beatrices uncle frequently advises her on business matters, but is not

convinced that the honey extractor will be more efficient and profitable than her current machinery.

He has suggested using capital budgeting to help with the investment decision.

The new honey extractor requires a capital outlay of $162,000 and will have a residual value of $50,000

at the end of its five year useful life.

It is expected that the new honey extractor will generate the following Net Cash Inflow:

Year Net Cash Inflow

1 $51,000

2 48,000

3 37,000

4 37,000

5 37,000

Beatrice uses straight-line depreciation on all machinery.

Beatrice requires a minimum 15 per cent accounting rate of return and a three year payback period

for any investment project. Beatrices cost of capital is 9 per cent.

1. Identify, using examples, TWO (2) specific risks associated with investment in the proposed

new honey extractor AND explain how these risks could impact the business.

(8 marks)

2. Draw the cash flow time line for the investment in the proposed new honey extractor and

indicate the cash flow patterns represented on the cash flow time line.

(5 marks)

3. Calculate the annual depreciation expense for the proposed new honey extractor.

(5 marks)

4. a) Calculate the average accounting rate of return (ARR) of the proposed new honey

extractor. (10 marks)

b) Given your answer above (calculate ARR), should Beatrice invest in the proposed new

honey extractor? Explain your answer. (2 marks)

5. a) Calculate the payback period (PP) of the proposed new honey extractor. (5 marks)

b) Given your answer above (calculate PP), should Beatrice invest in the proposed new honey

extractor? Explain your answer. (2 marks)

6. a) Calculate the net present value (NPV) of the proposed new honey extractor. (10 marks)

b) Given your answer above (calculate NPV), should Beatrice invest in the proposed new

honey extractor? Explain your answer. (2 marks)

7. a) Compute the internal rate of return (IRR) of the proposed new honey extractor. (15 marks)

b) Given your answer above (calculate IRR), should Beatrice invest in the proposed new

honey extractor? Explain your answer. (2 marks)

8. Briefly discuss whether, and if so how, depreciation affects your calculations in Questions 4-7.

(8 marks)

9. Identify, giving reasons, TWO (2) pieces of additional information that would aid Beatrice in

deciding whether or not to invest in the new honey extractor.

(6 marks)