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Alan and Jamie, proprietors of Tai & Wong Interior Designs, are considering the purchase of new computer hardware and software. This will allow speedier preparation of drawings and quotations to customers’ specification and should result in additional profits due to increased customer orders. The following estimates apply:

                Initial cost of hardware and software                                      £40,000

                Useful life                                                                                           4 years

                Profit increase if bought:

                                Year 1                                                                                    £2,000                  

                                Year 2                                                                                    £6,000  

                                Year 3                                                                                    £6,000

                                Year 4                                                                                    £8,000  

                Resale value at the end of Year 4                                              £4,000                  

 

The profit increases above are stated after deducting depreciation (which is calculated on a straight line basis) from the proposal’s projected net cash inflows. Alan and Jamie require an ARR of 15% and a PP of 2 years.

 

Required: 1. Advise Alan and Jamie as to whether the investment would meet their criteria.

 

 

2. Assuming a cost of capital of 15%, calculate NPV of project and advise Alan and Jamie as to whether to invest.

 

 

3. Using costs of capital of 15% and 25%, calculate the IRR of the project. What does this mean?

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