Question

2. Calculate Average return and evaluate whether the com the company should accept or reject the project and why? 3. Calculate Net present value and evaluate whether the company should accent reject the project and why? Year Cash Flow PV if r&n Present value

Answer 1

2. The Accounting Rate of Return (ARR) is defined as

ARR = Average Net Income/ Capital Investment

In this case, the average Net Income is = (20,000+ 25,500 + 10,100 + 2,000) / 4 =14400

There fore, ARR = 14400/450000 = 0.032 = 3.2%

As this rate is less than the hurdle rate or the required rate of 18%, the company should reject the project

(Note that even if we take Net Income of only first 3 years, then also

ARR = 4.1% , which will also lead us to reject the Investment in the asset.)

3. The NPV table can be prepared by taking

PVIF(r,n) = 1/ (1+r)ⁿ   where r= discount rate = required rate of return = 18% and n=the year of cashflow

PV = Cash flow * PVIF (r,n)

Year(n)	Cash Flow (CF)	PVIF(r,n)	Present Value
1	250,000	0.8475	211864.4
2	150,000	0.7182	107727.7
3	150,000	0.6086	91294.63
4	60,000	0.5158	30947.33
		Total PV	441834.03

Thus the Present value of Cash inflows is 441834.03

Thus NPV = -450000+441834.03 = -8165.97

Thus, by NPV method also the Company should reject the Investment as the NPV is negative