Question

Consider Table 1. Public Life Inc. is considering investing in projects 1 and 2. The initial cost of project 1 is 10,000 and e3,000 for project 2. Each project lasts four years. Straight-line depreciation method is used The minimum accounting rate of return is 10%. The discount rate is 10% for both projects, and the depreciation rate is 25% for each project. 2. Table Project 1 Years Project 2 Years 2 0 2 0 Barnings Cashflows 4 60 120 180 30 -10,000 2,900 5,000 3,600 2400 -3,000 785 855 920 775 30006000 (a) Consider Table 1. Calculate the net present value for each project and rank the projects. (b) Consider Table 1. Calculate the accounting rate of return for each project and rank the projects (c) Consider Table 1. Calculate the internal rate of return for each project and rank the projects. (d) Assume for now that the firm can invest in a single project only. Based on your calculations performed in parts (a)-(c) of this question, which project would you recommend Public Life Inc. to invest in and why?

Answer 1

Answer (a):

NPV and Ranks are as follows:

Workings:

Answer (b):

Accounting Rate of return and ranks are as follows:

Workings:

Answer (c):

IRR and ranks are as follows:

Workings:

Please see table to answer (a) above

Answer (d):

Project 1 is recommended.

The discount rate is 10% and minimum required accounting rate of return is 10%.

NPV of Project 1 is positive (at discount rate = 10%) and hence project 1 is acceptable. NPV of project 2 is negative and hence project 2 is rejected.

IRR of project 1 is at 15.21% which is greater than discount rate of 10%. Hence project 1 is acceptable based on IRR. IRR of project 2 is at 4.36% which is less than discount rate of 10% and hence project 2 is rejected.

ARR of project 1 is 19.50% which is higher than required ARR of 10%. Project 2's ARR is at 5.58% which is less than the required ARR.

Hence Project 1 is acceptable based on all 3 criteria. Project 2 is rejected based on all 3 criteria.