Ridag Co is evaluating two investment projects, as follows.

Project 1

This is an investment in new machinery to produce a recently-developed product. The cost of the machinery, which is payable immediately, is $1·5 million, and the scrap value of the machinery at the end of four years is expected to be $100,000. Capital allowances (tax-allowable depreciation) can be claimed on this investment on a 25% reducing balance basis. Information on future returns from the investment has been forecast to be as follows:

This information must be adjusted to allow for selling price inflation of 4% per year and variable cost inflation of 2·5% per year. Fixed costs, which are wholly attributable to the project, have already been adjusted for inflation. Ridag Co pays profit tax of 30% per year one year in arrears.

Project 2

Ridag Co plans to replace an existing machine and must choose between two machines. Machine 1 has an initial cost of $200,000 and will have a scrap value of $25,000 after four years. Machine 2 has an initial cost of $225,000 and will have a scrap value of $50,000 after three years. Annual maintenance costs of the two machines are as follows:

Where relevant, all information relating to Project 2 has already been adjusted to include expected future inflation. Taxation and capital allowances must be ignored in relation to Machine 1 and Machine 2.

Other information

Ridag Co has a nominal before-tax weighted average cost of capital of 12% and a nominal after-tax weighted average cost of capital of 7%.

Required:

Calculate the net present value of Project 1 and comment on whether this project is financially acceptable to Ridag Co.