Question

Q.3. Alia company is considering the purchase of a new machine. Two alternative machines C and D have been suggested, each having an initial cost of 520,000 SR and requiring 30,000 SR as additional working capital at the end of first year. Earning after taxation are expected to be as follows:

Years	Cash Inflows Machine C (SR)	Cash Inflows Machine D (SR)
1	136,000	160,000
2	148,000	180,000
3	175,000	215,000
4	190,000	185,000

The company has targeted of return on capital of 5% and on this basis, you are required to compare the profitability of the machines and state which alternative you consider financially preferable. The present value of 1 (one) SR at 5% is 0.952, 0.907, 0.864, and 0.823 respectively from first to fourth year.

Answer 1

	Statement showing NPV for Machine C	Statement showing NPV for Machine D
Years	Net Cash Flows	Discount Factor	PV of Cash Flows at 5%	Net Cash Flows	Discount Factor	PV of Cash Flows at 5%
1	136000	0.952	129472	160000	0.952	152320
2	145000	0.907	131515	177000	0.907	160539
3	175000	0.864	151200	215000	0.864	185760
4	190000	0.823	156370	185000	0.823	152255
	Total of PV of CashFlows		568557			650874
	Less:Investment		520000			520000
	NPV		48557			130874
	Since the NPV of Machine D is more than the NPV of Machine C, Hence Machine D is more preferable
	Average Annual Inflows =568557 / 4 =142139
	Average Investment =(520000 / 4) =130000
	Accounting Rate of Return for Machine C =(142139 / 130000)*100 =109.34%
	Average Annual Inflows =650874 / 4 =162719
	Average Investment =(520000 / 4) =130000
	Accounting Rate of Return for Machine C =(162719 / 130000)*100 =125.17%
	So in terms of Return also Machine D is more preferable