Question

INFORMATION

Medico Limited intends investing in a project during March 2021. The project is expected to cost R2 500 000 with a five-year useful life, and no residual value. The annual volume of production for the project is estimated at 150 000 units, which can be sold for cash at R12 per unit. Depreciation is expected to be R500 000 per year. Annual cash operating costs are as follows:

Variable costs R 225 000

Fixed costs R R750 000

REQUIRED Use the information provided above to calculate the following:

2.1 Net Present Value (3 marks)

2.2 Accounting Rate of Return on average investment (answer expressed to two decimal places) (3 marks)

2.3 Internal Rate of Return, if the net cash flows are R720 000 per year for five years (answer expressed to two decimal places). (4 marks)

Answer 1

NPV Calculation
			Unit	Rate	Amount
a	Annual Cash Inflow		150000	12	18,00,000
b	Annual cash outflow
	variable cost		225000
	Fixed cost		750000
			9,75,000
NPV	a-b	8,25,000
Calculation of Accounting rate of return (ARR) on average investment
c	Average Investment:		Book value at the beginning of year+Bookvalue at the end of the year
					2
			2500000
			2
			12,50,000
d	Average Annual Profit:		3,25,000	(as calculated below)
	ARR	(d/c)	0.26	i.e. 26%
Calculation of Annual profit
	Sales		18,00,000
Less:	Variable cost		2,25,000
Less:	Fixed cost		7,50,000
Less:	depreciation		5,00,000
annual profit			3,25,000