Part A

There is an opportunity to expand the existing business by purchasing a new machinery for production. The machinery costs $500,000 and will be depreciated on straight-line basis to zero over 5 years. If the machinery will increase the operating profit before depreciation by $150,000, $160,000, $170,000, $180,000, and $200,000 over these 5 years. What is the average accounting rate of return for the new machinery? Assume the machine is purchased with all equity and the tax rate is 30%.

 

Part B

There are two mutually exclusive investment opportunities. The initial investment for both projects are $100,000. The first investment will generate $20,000 per year in perpetuity. The second project is expected to generate $15,000 for the first year and the amount will grow at 2% per year after that. The first cash flow for both investments start at the end of the first year.

  1. Calculate the internal rate of return for both investments.
  2. Assume the cost of capital is 7%, calculate the NPV for both investments.
  3. Based on your answers in (a) and (b), which investment should you choose? Why?
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