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Investment Appraisal for Miggy and Brothers Co - Essay Example

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Miggy and Brothers Co (MBC) is a manufacturing firm specializing in the production of customized furniture. In order to increase its production efficiency, the company standardizes some of the components of the furniture. …
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Investment Appraisal for Miggy and Brothers Co
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MBC is considering three alternatives as replacements: model A which will be sourced from the United States; Model B which is a British machine; and model C which will be imported from France. All of these machineries cost $100,000 and are seen to improve the production efficiency of the company and reduce the costs incurred in manufacture. As these are new machines, MBC will be hiring and training personnel who will operate the new equipment. Exact amount is not yet determined but Model C, in particular is expected to incur the highest training cost since the machine is least user-friendly. Models A & B have local dealer which agree to maintain and repair the machines for MBC. In the case of Model C, MBC needs to seek French manufacturers to service the machine in case of emergencies.

The choice between the three machines under consideration can be justified by utilizing tools which tests the profitability of each investment. Three of the most frequently used assessment tools will be employed in MBC decision making. These are payback period, net present value analysis, and internal rate of return analysis.

Aside from the quantitative data given by the management, this report adjusted the figures to enhance the rationale of the choice. In this regard, the salvage value of the old machine to be replaced is reflected as cash flows in Models A, B, and C. It should be noted that as the acquisition of the new machine will entail discarding the old, all options will benefit from the revenue of selling the old one.
Due to equity considerations, this report opted to disregard the salvage value of the three machines on the sixth year. Since the salvage value of Models B and C cannot be determined, it is more rational to omit the revenue to be derived from the future sale of the machines.
3.1 Payback Period
The payback period is one of the simplest ways in ascertaining the feasibility of an investment. This tool is used to determine the length of time that the company can recoup its cash outlay (Keown, et al, 2005). Table 2 shows the computed payback period for the three options.
Table 2. Payback Period Computation
From the above computation, Model A has a payback period of 4 years while the company's investment in Models B and C will be recouped within a shorter period of three years.
3.2 Net Present Value
Net Present Value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows (Keown, et al, 2005).
Table 3. Net Present Value Computation
Table 2 shows the computation for the NPV of the three machines under consideration. Model A has an NPV of 6,434 while Models B and C generate discounted cash flows of -7,299 and 16,455, respectively.
3.3 Internal Rate of Return
The internal rate of return is the cost of capital which equates the NPV to zero (Keown, et al, 2005). Table 4 shows the different IRR for each model as computed by Microsoft Excel. Consistent with the NPV analysis, ...Download file to see next pagesRead More
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