A company is considering investing in a new production facility at a cost of $120 million. The new facility is expected to produce annual cost savings as set out in The facility is expected to have a useful life of eight years, before becoming obsolete and requiring replacement. The company has a policy of depreciating all assets on a straight line basis. Table 9.21
|
Year |
Annual cost savings |
|
1 |
$30m |
|
2 |
$35m |
|
3 |
$40m |
|
4 |
$45m |
|
5 |
$30m |
|
6 |
$26m |
|
7 |
$15m |
|
8 |
$15m |
Required:
Evaluate the investment using the following techniques:
(a) Payback period – the company considers a capital investment to be acceptable if it pays back within four years. Should the company make the investment?
(b) ARR – what is the accounting rate of return on the average capital employed?
(c) NPV – if the capital investment has a required rate of return of 12 per cent, what is its net present value? Should the company make the investment?