Report Law Siew Li (4335031) FIN 20014

A Report for Bright Lance Ltd

This report is to be presented to Mr. Larry Bright, Managing Director of Bright Lance
Ltd. This report aims to implement research on the feasibility of replacing the old
model machine (Mallow) which was acquired 3 years ago with a modern model
machine (Cranner) to assure that an optimum output level for the new product to be
launched the following year can be achieved. Investment appraisal methods used
include Net Present Value (NPV), Discounted Payback Period (DPBP), Profitability
Index (PI) and Internal Rate of Return (IRR) to assess the viability of the
replacement project.

First, NPV is an evaluation of how much value is made by accepting an investment.

It is a direct evaluation of ensuring the achievement of the objective of financial
management – to raise shareholders’ wealth. Next, DPP shows the time needed for
an investment’s discounted cash flows to match its original cost. PI is the present
value of an investment’s future cash flows divided by its original cost. Lastly, IRR is
the required return that lead to a zero NPV when is it utilised as the discount rate. It
is noted that the consultants’ fee ($33,000) and separate fee ($65,000) are treated
as sunk costs and considered irrelevant since they are incurred regardless of
whether or not the project proceeds. Counting in sunk costs will cause undervalued
NPV. Borrowed funds are also ignored because it is treated as a finance charge
classified under the financing decision rather than the investment decision.

Since the calculated NPV is positive ($44,569.04), the replacement project is

acceptable since it is implied that it will enhance the value to the company. Also, the
DPP is 1.98 years, which is less than the optimal replacement life of new machine (3
years). Therefore, this replacement project is acceptable because the new machine
only needs 1.98 years for its discounted cash flows to equal its original cost. The PI
is greater than 1.0 (1.45) thus this project is acceptable as the present value of the
inflows are above the outlay, indicating benefits greater than its original cost. Lastly,
the IRR is 32.21% which is greater than the required interest rate of return (12%)
consequently making the project acceptable.

In conclusion, Bright Lance Ltd should replace the old model machine (Mallow) with
the modern model machine (Cranner) to ensure optimum output level for the new

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Report Law Siew Li (4335031) FIN 20014

product. The replacement project is expected to enhance value for the company due
to the positive NPV ($44,569.04), as well as requiring only 1.98 years for its
discounted cash flows to equal its original cost. Furthermore, the PI of this project is
greater than 1.0 (1.45), the present value of the inflows is more than the outlay and
the IRR (32.21%) is greater than the required interest rate of return (12%). Mr. Larry
Bright is advised to make early planning in implementing the replacement project to
be sure of achieving optimum output in order to maximise profits in the following year.

(490 Words)

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