Recommendation about proposed investment :

Selection of any project/machinery will depend upon following criteria :

1. Non discounted cash flow criteria :

a. Payback period(PB) :
Project would be accepted if its payback is less than the standard payback. The greatest
limitation of this method is that it does not consider the time value of money. To overcome

this limitation the discounted payback period is suggested with certain discounting rate.
b. Average rate of return (ARR) :
Project is accepted if its ARR is greater than the cut of rate. This method is based on
accounting flows rather than cash flow, therefore it does not consider time value of money.
2. Discounted cash flow criteria :
a. Net Present Value (NPV) :
Acceptance rule
Accept if NPV >0
Reject if NPV<0
Project may be accepted if NPV = 0
b. Internal Rate of Return (IRR) :
Acceptance rule
Accept if IRR>k (opportunity cost of capital)
Reject if IRR<k
Project may be accepted if IRR= k
c. Profitability Index(PI) :
Acceptance rule
Accept if PI > 1.0
Reject if PI<1.0
Project may be accepted if PI =1

In general, discounted cash flow criteria is applied to choose a project /machinery from different
investment proposal.

From the calculation we can see that payback period for both the machine is same and PI also greater
than one for both the cases. Since NPV is higher for the case of machine B we should recommend to go
ahead with the new machine which would further increase capacity as compared to machine A.

Note : All calculations are attached in Question 2 .