Question 5 (25 marks)

Anzo Innovations and Technology (AIT) is a large company based in Oxford that produces a range of technological and innovative products that are sold around Europe.

The directors of AIT are considering a major investment to launch smart gardening products that are capable of monitoring an entire garden and feed information to the user via a mobile phone application with recommendations such as when to water, fertilise and plant.

AIT employed a market-testing organisation to conduct a market study based on their initial prototype. Their initial study cost 250,000 and provided promising results. This study confirmed the products potential in the market.

AIT will need to invest in new machinery to manufacture these new smart gardening products. The CFO, Mrs Siddique, has identified two machines to develop this new product. However, Mrs Siddique suggests that the firm only requires one machine to meet the estimated demands. Each machine will have an estimated life of five years with no residual value. The data gathered in relation to each of the machines is shown in Table 2.

Table 2 Net cash flows for new machinery options

	Project net cash flows ()
	Machine A	Machine B
Year 0	(2,600,000)	(3,200,000)
Year 1	740,000	1,170,000
Year 2	870,000	1,200,000
Year 3	890,000	1,190,000
Year 4	980,000	1,100,000
Year 5	1,180,000	920,000

The company uses straight-line depreciation and its cost of capital (discount rate for investment appraisal) is 15%.

• a.Calculate the payback period, net present value (NPV) and internal rate of return (IRR) of the proposed investments and advise the company, on financial grounds, which machine it should invest in. (20 marks)
• b.The CFO of AIT, Mrs Siddique, tells you that she finds it easier to understand IRR compared to NPV. Write a report to the CFO comparing NPV and IRR, and their relative merits and drawbacks. You can use any method taught in the module (calculating manually, using discount tables or using a spreadsheet) to calculate NPV and IRR. (5 marks)