Task two

1. The payback period shows how long it takes for a business to recover its investment. It considers
the amount of time required to return the investment. It is a simple measure of risk as it shows
how fast the money can be returned from an investment. For example, if a company wants to
recover the cost of a machine within 5 years the purchase of machine would be desirable if it is
promises a payback period of 5 years or less it is because maximum desirable payback period of
a company would be 5 years.

Payback period is the easy way to compare the several business project and short term payback
period can improve the liquidity position and it reduces the risk of loss. Therefore, payback
period is preferred because risk on uncertainty of return is low and also fund will available soon
if we invest in short payback period which can invest in another project.

Payback period does not consider the time value of money. It ignores the project’s profitability
and also does not consider a project’s return on investment.

2. Accounting rate of return: ARR means the percentage income that an investment will make
over a period of time calculated by dividing the investment income by the investment cost. It
helps investor to analyze the risk involved in making an investment. It calculated over one or
more years of project and if calculated over several years, the average of investment and
revenue are taken.

ARR is easy to calculate and simple to understand. It recognized the concept of net earnings and
provide the clear thought of the profitability of a project as well as it measures the current
performance of the firm.

Fair rate of return cannot be determined and create a problem in making decision. It is not able
to evaluate the project and does not consider the factor which are affecting the profitability of
the project and this method is only focused on the accounting profits.

3. Net present value:

It is the future value of all cash flows over the entire life of an investment discounted to the
present. It is generally used for determining the value of business, investment security, capital
project and anything that involves cash flow. It helps in maximizing the firm’s value and also give
 more important to time value of money but it is difficult to calculate the appropriate discount
rate and it may not give correct decision when the projects are unequal life.

4. Internal rate of return: IRR is a tool used in capital budgeting to estimate the profitability of
potential investments. It is the discount rate which makes the net present value of all cash
inflow equal to zero. Different project with the different can be calculated by IRR.

b. Explain briefly which machine you would recommend to senior

management of LMU Plc under each technique and state your
reason why you would recommend that machine.

Payback period shows how long it takes to recover from its investment and payback period for
super machine is 4 years and 5 years for deluxe machine. Payback period says that the lower the
payback period lower the risk of recover. Now, super has lower payback period than deluxe it
means there is low risk of recover for super machine. It has the payback period with 250000
pounds and has the depreciation of 40000 every year. Similarly, ARR measure the current
performance of a firm. Though the cost of investment of deluxe is more than super, deluxe
earned more profit but its investment will be ow in return than super. Again the net profit value
measures the time value of money as well as profitability. The NPV of super is 55528.96 pounds
and the deluxe is 29160 pounds. Super has more value than deluxe. IRR of super is higher than
deluxe but super has higher return on investment than that of deluxe. So, super machine is
more favorable for LMU Plc than deluxe because with low investment super receive higher
return investment and super have low payback period which decrease risk of recover
investment.
 Deluxe

Cash Cumilative Cash

Year   Flow Flow
-
Cost 400,000   -400,000
1   75,000 -325,000
2   100,000 -225,000
3   125,000 -100,000
4   50,000 -50,000
5   50,000 0
6   125,000 125,000

Payback 5 years

Super

Net Cash
Year   Inflow Cumilative CashFlow
Cost -250,000   -250,000
1   125,000 -125,000
2   50,000 -75,000
3   50,000 -25,000
4   25,000 0
5   75000 75,000
6   50,000 125,000

Paybac
k 4 years
    Super          
               
Cost   250,000          
            Average Profit 22,5
Average
Year   Net Cash Inflow Less Depreciation Accounting Profit   Investment 130
1   125,000 40000 85,000      
2   50,000 40000 10,000   ARR 17%
3   50,000 40000 10,000      
4   25,000 40000 -15,000      
5   75000 40000 35,000      
6   50,000 40000 10,000      
               
Scrap
Value   10,000          

    Deluxe          
               
Cost   400,000          
               
Year   Cash Flow Less Depreciation Accounting Profit   Average Profit 27,5
Average
1   75,000 60000 15,000   Investment 220
2   100,000 60000 40,000      
3   125,000 60000 65,000   ARR 13%
4   50,000 60000 -10,000      
5   50,000 60000 -10,000      
6   125,000 60000 65,000      
               
Scrap
Value   40,000          
  Super    
Cost   -250000  
       
Year   Cash Flow Present Value
0     -250000
1   125,000 115,740.74
2   50,000 42866.94102
3   50,000 39691.61205
4   25,000 18375.74632
5   75000 51043.73978
6   60,000 37810.17761
       
NPV     55528.95752

  Deluxe    
       
       
Present
Year   Cash Flow Value
0     -400,000
69444.4444
1   75,000 4
2   100,000 85,733.88
99229.0301
3   125,000 3
4   50,000 36,751.49
5   50,000 34,029.16
6   165,000 103,977.99
       
NPV     29,166
  Super      
      17% 8%
Cash Present Present
Year Cost Flow Value Value
-
0 250000   -250000 -250000
125,00 106837.606 115740.740
1   0 8 7
36525.6775 42866.9410
2   50,000 5 2
31218.5278 39691.6120
3   50,000 2 5
13341.2512 18375.7463
4   25,000 1 2
34208.3364 51043.7397
5   75000 3 8
37810.1776
6   60,000 23390.3155 1
         
55528.9575
IRR     -4478.28465 2

  Deluxe      
      8% 11%
Present Present
Year Cost Cash Flow Value Value
0 -400000   -400000 -400000
69444.4444 67567.5675
1   75,000 4 7
85733.8820 81162.2433
2   100,000 3 2
99229.0301 91398.9226
3   125,000 3 6
36751.4926 32936.5487
4   50,000 4 1
34029.1598
5   50,000 5 29672.5664
103977.988 88215.7379
6   165,000 4 5
         
 29165.9975
IRR     3 -9046.41338