INTRODUCTION This report contains the explanation and analysis for the evaluation of whether a new machine should

be purchased in a 5year project investment. The aim of preparing this report is to give a clear view and better understanding regarding the data of Hawthorne Hospital Equipment Ltd., in order to evaluate whether the proposed investment would bring changes in the firms relevant cash flow, and adds value to the firm. Cost that are incremental and that result from the project is accounted for in the project cash flow analysis. The incremental cash flows consist of any and all changes in the firms future cash flows that are a direct consequence of taking the project. All calculations in this assignment will be done using EXCEL. ANALYSIS Data identified as incremental costs that is directly extracted from the assignment question includes Installation cost, modification fees and salvage value of machine. It is important that we take into account the calculation for depreciation tax on machine. As the method for calculating depreciation is in straight-line method and depreciated for tax purposes at 20 per cent; We will first calculate the new machine depreciation per year then minus the depreciation of old machine per year and then times 30% which we will get $51,840 per year. It is also highly essential to count the amount of tax gain/loss on salvage value, for the old machine it should value at $403200 after two years depreciation; however the old machine can be sold for $185,000 which makes losses of $218200. Therefore, there will be a tax on losses of $65460. For the new machine, the value of the machine at the end will be $0, but they can be sell for 220,000 which there will be a tax on gain of $60,000. The firm requires a payback period of three years. The payback

period is the amount of time required for an investment to generate net cash flows sufficient to recover its initial cost. From the cash flow analysis, the initial investment is $1099540. After the first three years, the firm has recovered $890520, leaving $309480 outstanding. Since the cash flow in the last 2 years is $753680, the payback occurs sometime in that year. Itis found that payback will occur 28% of the way into the year. The payback period is thus 3.28 years. Based on the payback rule, this investment is not acceptable, as it has overlapped the firms required payback period of three years. PROFITABILITY ASSESSMENT Estimating NPV is one way of assessing the profitability of a proposed investment. NPV is known as net present value; it is used to find out the difference between the investments market value and its cost. It is a measure of how much value is created or added today by undertaking an investment. To estimate NPV, the present value of the future cash flows is first calculated at twelve per cent discount rate. However, since Excel is used, by simply keying in the correct cash flow figures and discount rate, it is found that it yields a positive amount of $159053.10. The net present value decision rule states that an investment should be accepted if the net present value is positive, and rejected if it is negative. Therefore in terms of profitability, this investment should be accepted. Besides NPV, another alternative is to use the internal rate of return, which is also known as the IRR. The IRR on an investment is the required return that results in a zero NPV when it is used as the discount rate. Again, using Excel easily calculates the amountIRR is 14%. Based on the IRR rule, an investment is viable if the IRR exceeds the cost of capital. In this case, the firms cost of capital is 9 per cent. Since the IRR is greater than cost of capital, investment is deemed viable. Profitability index (PI) is one of the methods used to evaluate

projects as well. This index is defined as the present value of the future cash flow divided by the initial investment. Therefore PI is 1.14, which means for every dollar invested, $1.14 in value results. Lastly, the more commonly used method that is widely understood by most people is the payback rule. The payback period is the length of time it takes to recover the initial investment. To know whether an investment is acceptable or not, its calculated payback period must be less the pre-specified number of years. The specified payback period for Hawthorn Hospital Equipment Limited Ltd is three years. However, the payback period calculated on the investment is 3.28 years, which makes the investment unacceptable.

QUALITATIVE FACTORS NPVs cannot normally be observed in the market; instead, they must be estimated. Because there is always the possibility of a poor estimate, multiple criteria is used to provide additional information about whether a project truly has a positive NPV. This is where IRR comes in. The IRR is closely related to NPV, and these two are often used together (in the decision making process) and referred to as discounted cash flow techniques. The IRR and NPV rules always lead to identical decisions in the event where the projects cash flows is conventional and when the project is independent. Nevertheless, the usage of the IRR may lead to a problem arising in mutually exclusive investment decisions even if there is a single IRR. In other words, if two investments are mutually exclusive, taking one of them means we cannot take the other. To solve this problem, the investment with the largest NPV is chosen. This is because IRRs can often be found misleading.

The PI is very similar to NPV. However one of the disadvantages is it may lead to incorrect decisions in comparisons of mutually exclusive investments. The ranking problem is similar to the IRR ranking problem. When comparing the payback period rule with the NPV decision rule, the former is rather flawed primarily because it ignores risk and the time value of money. It is said to ignore risk due to the failure of considering risk differences between projects; and there is no discounting involved, thus the ignorance of the time value of money. Ignoring cash flows beyond the cut-off point might lead us to reject profitable long-term investments too. In conclusion, due to the positive NPV obtained, together with the IRR that is above cost of capital and the PI, which is greater than one; it appears that the investment of Hawthorne Hospital Equipment Limited is viable and worthwhile investing.