Investment Appraisal ( from C. Drury, Management and Cost Accounting / CH 14) - Case Study Example

Using the current crane, Fosters Construction Limited generates revenue worth £ 20 million per year. The old crane is five years old now, and it has an economic life of ten years. According to the meeting held, the performance of the company could decline due, in part, to operation inefficiencies of the old crane. For the sake of the case, it is assumed that the gross revenue generated by the new machine is £ 195,000, while that generated by the old crane is £ 140,000. The original cost of AL II is £ 345,000, a running cost of £ 60,000 per year, and a scrap value of £ 30,000.

Based on the information, the depreciation expense of the new crane = (345,000 – 30,000) /10 = £ 31,500. On the other hand, the depreciation expense of the old crane = (195,000 – 5,000)/10 = £ 19,000 (Thomsett, 2002). Therefore, the net present value and the payback period of the new crane are determined to be £ 38,841 and six years, 11.77 months (Rounded off). See Exhibit 1 below. Based on the decision rule for decision-making under the NPV, projects with a positive NPV should be undertaken.

Therefore, the new crane qualifies under the assessment. However, Fosters Construction Limited has a preferred payback period (5 years). Based on the exhibit 1 below, the payback period is six years, 11.77 months, which is more than five years preferred by the company. The two methods leads to a contradicting decision (Baker & English, 2011). The required rate of return is the reward investors expect to get from an investment. The nominal required rate of return is the return on investment that does not reflect the current economic condition (the present value of money).

In other words, the nominal RRR is that which is not adjusted for the current inflation rate. On the other hand, the real required rate of return is that which is adjusted for the inflation. That is, it reflects the inflation effect on the value of the returns. For instance, if the nominal