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Trade Winds Enterprises Ltd (Tw) has £20 two capital investment projects, which have cash flows as shown below. ,000 that it can invest in any or all of the Comparison of Project Cash Flows* Year of Cash Flow Year 0 Year I Year 3 Type of Cash Flow Project Year 2 (E10 000) Investment Revenue Operating expenses Investment Revenue Operating expenses A. £10000 11,000 30 000 4 889 15 555 B. (10 000) £5 000 10000 2222 15 555 5555 2 222 TWs The investment will be depreciated to zero on a straight-line basis for tax purposes. marginal corporate tax rate on taxable income is 40% None of the projects will have any salvage alue at the end of their respective lives. For purposes of analysis, it should be assumed that all cash flows occur at the end of the year in question. Rank TW s two projects according to the following three commonly used capital budgeting criteria: . Payback period. .Accounting return on investment (ROI). . Net present value (NPV), assuming alternately a 10% discount rate (Present Value and Annuity tables are provided) If the projects are independent of each other, which should be accepted? If they are mutually exclusive (i.e, one and only one can be accepted), which one is best?
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Answer #1

Ranking:

As per payback period project B is first rank and project A is second rank

As per ROI project A is first rank and project B is second rank

As per NPV project A is first rank and project B is second rank

independent of each other then both can be accepted as NPV is positive and if it is mutually exclusive Project A is best

Project A Revenue Operating expenses Depreciation EBIT Tax(40%) Net income Operating Cash Flow Net Income Depreciation Operating cash flow Total Cash Flow Initial Inv Operating cash flovw Net working capital Salvage value Total Cash flow NPV Accounting return Payback period 0 2 3 Project B Revenue 30,000.00 10,000.00 5,000.00 ,555.00 2,222.00 3,333.33 3,333.33 555.33 222.13 333.20 10,000.00 11,000.0030,000.00 5.555.00 4,889.00 15,555.00Operating expenses 3,333.33 15,555.00 3,333.33 11,111.67 4,444.67 6,667.00 3,333.33 1,111.672,777.67 11,111.67 3,333.33 Depreciation EBIT Tax(40%) Net income Operating Cash Flovw Net Income Depreciation 444.67| 667.00 1,111.07| 1,666.60 1,111.67 444.67 667.00 4,444.67| 6,667.00 667.00 3,333.33 1,666.60 3,333.33 6,667.00 3,333.33 10,000 6,667.00 3,333.33 10,000 667.00 333.20 3,333.33 3,333.33 4,000 perating cash flow Total Cash Flow Initial Inv Operating cash flovw Net working capital Salvage value Total Cash flow NPV Accounting return Payback period 10,000 10,000 5,000 10,000 10,000 3,000 10,000 5,282.24 63.34% 10,000 10,000 4,651.32 56.67% 10,000 net cash flow Cumm cash floe 10,000.00 (5,999.67) (999.73) 9,000.60 net cash flowCumm cash floe 10,000.00 Year Year 0 10,000.00 4,000.33 4,999.93 10,000.33 0 10,000.00 10,000.33 4,000.33 3,000.13 4,000.67 7,000.80

1 Project A 3 Revenue 4 Operating expenses 5 Depreciation 6 EBIT Project B Revenue Operating expenses 11000 4889 10000 10000 5000 15555 -10000/3 13-14-15 10000/3 10000/3 D3-D4-D5 :D6*4096 D6-D7 -10000/3 -E3-E4-E5 E6*4096 10000/3 J3-J4-J5 10000/ K3-K4-K5 -K6*4096 K6-K7 EBIT Tax(40% Net income Operatine Cash Flow Net Income Depreciation Operating cash flow Total Cash Flow Initial Inv Operating cash flowH12 et working capita Salvage value Total Cash flow NPV Accounting returnE-AVERAGE 118:K18)/H18 Payback period -C6 40% C6-C7 6* 4096 -16-17 8 Net income 9 Operating Cash Flow 10 Net Income 11 Depreciation 12 Operating cash flovw 13 Total Cash Flow 14 Initial Inv 15 Operating cash flow B12 16 Net working capital 17 Salvage value 18 Total Cash flow 19 NPV E6-E7 18 D5 CS C10+C11 D10+D11 E10+E11 110+111 J10+111 EK10+K11 10000 10000 D12 K12 UM C14:C17 SUM D14:D17) SUM(E14:E17) SUM H14:H17 -SUM(114:117)SUM14:117) -SUM(K14:K17 SUM(B14:B17 B 18+NPV( 10%,C18:E 18) 2H18+NPV(10%,118:K18) Accounting return-AVERAGE(C18:E18)/B18 ayback period EA26+1-C26/B27 G24+(-124/H25) net cash flow -10000 4000.33333333333 4999.93333333333 10000.3333333333 Cumm cash floe ear net cash flow Cumm cash floe 824 -C24+B25 C25+B26 C26+B27 10000 10000.3333333333 4000.33333333333 3000.13333333333 H24 -124+H25 125+H26 -126+H27 26 2

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