Question

Eenhana Local Government in an effort to boost its revenue base decided to acquire a tractor that will be hired out to farmers at affordable charges. The tractor will cost N$ 300,000 and will generate an annual net cash inflow of N$140,000 for six years. The cost of borrowing to procure the tractor is 10%. 

Required: 

Using the Profitability Index Technique of Investment Appraisal and Net Present Value (NPV), advise the chairman of Eenhana Local Government whether to invest in the project or not. 

Discount Factors to be used are: 

Answer 1

NPV

Year	cash flows	Discounting factor	Discounting cashflows
0	initial investment	A	($300,000)
1	$140,000	0.9091	$127,274
2	$140,000	0.8264	$115.696
3	$140,000	0.7513	$105,182
4	$140,000	0.6830	$95,620
5	$140,000	0.6209	$86,926
6	$140,000	0.5645	$79,030
	Total	B	$609,728
	NPV	B-A	$309,728

Profitability Index = PV value of cashflows/initial investment

=$609,728 / $300,000

= 2.032

Conclusion

By seeing in to Positive NPV and Profitability Index more than 1, investment in purchase of tractor is atmost feasible. Hence Eenhana Local Government can invest .