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Answers to supplementary objective test questions

11.2 A

Calculate the company’s money cost of capital:

Real rate = 4.54% General inflation rate = 10%

Money rate = (1.0454 × 1.1) – 1 = 0.1499 = 15%

Find the NPV at 15%

Production
costs Revenues
(rising at (rising at Net cash DF @ Present
Year Investment 10% p.a.) 5% p.a.) flow 15% value

$ $ $ $ $
0 –250,000 –250,000 1 –250,000
1 –165 ,000 800, 000 635,000 0.87 552,450
2 –181,500 840,000 658,500 0.756 497,826
3 –199,650 882,000 682,350 0.658 448,986
1,249,262

11.3 C

Sensitivity analysis involves recalculating the outcome using different
assumptions about a given variable to determine the impact of changes in the
variable on the overall outcome.

11.4 The company should therefore choose machine B. This will represent a saving
of $2,946 in present value terms.

We must first calculate the NPV of the two options, then convert the NPV of
each into an annual equivalent cost

Machine A Machine B
DF CF PV CF PV
0 1 80,000 80,000 110,000 110,000
1 0.909 15,000 13,635 12,000 10,908
2 0.826 11,000 9,086 12,000 9,912
3 0.751 12,000 9,012
102,721 139,832
Cum DF 1.736 2.487
59,171 56,225

Machine B is the cheapest option.

The difference is $2,946.

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