Question

QUESTION 1 The following information relates to three possible capital expenditure projects. Because of capital rationing, only one project can be accepted. The following information relates to three possible capital expenditure projects. Because of capital rationing, only one project can be accepted. Project A Project B Project C Initial cost R400 000 R460 000 R360 000 Expected life 5 years 5 years 4 years Expected scrap value R20 000 R30 000 R16 000 Expected net cash inflows: R R R 200 000 110 000 140 000 65 000 100 000 95 000 End of year 1 160 000 2 140 000 3 130 000 4 120 000 5 110 000 The company estimates its cost of capital is 18%. 100 000 100 000 100 000 Required 1. Calculate the payback period for project B. (Answer must be expressed in years and months) 2. Calculate the accounting rate of return for project C. (Answer expressed to 2 decimal places) 3. Calculate the net present value of each project. (Round off amounts to the nearest Rand) 4. Using the answers from question 3.3, which project should be chosen? Explain why.

Answer 1

I Payback period for Project B Year 0 1 2 Cash flow (400,000) 200,000 140,000 100,000 100,000 130,000 Cumulative Cash flow (400,000) (200,000) (60,000) 40,000 140,000 270,000 3 4 5 Payback Period:2 year + 60000/(60000+40000) Payback Period:2 year 0.6 months Depreciation Accounting Rate of return Year Cash flow 1 110,000 2 65,000 3 95,000 4 100,000 (86,000) (86,000) (86,000) (86,000) Net Profit 24,000 (21,000) 9,000 14,000 26,000 6,500 (26000/4) Average Income Accounting rate of Return=Average Income/Initial Investment Accounting Rate of return=(26000/360000) X 100 7.22% Depreciation Cost Salvage No of year Depreciation 360,000 16,000 4 86,000 (360000-16000)/4 MIL Net Present Value Year PV Factor(18%) Project A 1 Cash Inflows Project B 2 3 160,000 200,000 140,000 140,000 130,000 100,000 120,000 100,000 110,000 100,000 3 0.847 0.718 0.609 0.516 0.437 Present Value of cash inflows Less:Initial lonvestment Net Present Values Present Values Project C Project A Project B Project C 4 5=1 X 2 6= 1 X3 7=1 X4 110,000 135,593 169,492 93,220 65,000 118,644 118,644 55,085 95,000 110,169 84,746 80,508 100,000 101,695 84,746 84,746 93,220 559,322 542,373 313,559 (400,000) (460,000) (360,000) 159,322 82,373 (46,441) 4 5 84,746 IV On the basis of NPV, Project A should be chosen as NPV is more as compared to other project We can Calculate Profitalibility Index also Project A Project B Project C Present Value of cash inflows А 559,322 542,373 313,559 Initial Investment B 400,000 460,000 360,000 Profitability Index(A/B) 1.40 1.18 0.87 Based on PI, Project A should be chosen