Question

subject: Managerial accounting.

can you please answer in a simple way, step by step.

Question 1. Jetblack Ltd. are currently considering two alternative projects Alpha & Beta. The details of the projects are as follows: Alpha: This project would require an initial investimcent of £180,000 which would be payable 50% on commencement of the project and he balance at the end of the first year. The working capital requircment is expected to be £20,000 and will be nccessary at the beginning of the project. This project will last for four years with a residual valuc of at the end of its useful life. The cash inflows are expected to be: Year E65,000 85,000 106,000 75,000 Beta: This projeet will last for five years with a residual value of £12,000 at tho end of the five year period. The initial cost of the project is expected to be £260,000 payable immediately. Working of £15,000 will be required, on commencement. The cash inflows from the project are expected to be: 90,000 80,000 55,000 50,000 35,000 cost of capital of 10%. The company has Required: For each project calcalate (a) Payback (i) Net Present Valde (NPV) (ii) (20 marks) (b) Advise management whether it should accept project Alpha or project Beta giving reasons. s marks) e biscount:Factors @ 10%..าใ 909 2826 4683 .621い 564 (25 marks)

Answer 1

a-i) The Payback period (nothing but the traditional or conventional recovery period) is the period within which, cash outflows associated with the project can be recovered by the management but without considering time value of money. The answer is expressed in terms of number of periods (may be weeks or months or years, etc.). To calculate the payback period, cumulative cash flows year-by-year shall be calculated and then the year in which cumulative cash flows turns into positive is the payback period. However, in order to calculate exact payback period in decimal places, negative cumulative cash flows of previous year shall be divided by current year's cash flows and the decimal thus calculated shall be added to previous year to the year in which cumulative cash flows turned into positive Cumulative Cash Flows CALCULATION: Alpha Alpha Beta Beta Year Alpha 2 years(50,000 106,000) 2.47 years; Beta 3 years(50,000/ 50,000) 4.00 years; 0 £110,000 -£275,000 £110,000 -£275,000 E25,000 £90,000 £135,000 -£185,000 E85,000 E80,000 2 E50,000 £105,000 E106,000 E55,000 £56,000 £50,000 E120,000 50,000 4 E176,000 EO EO £62,000 £176,000 £62,000 Payback Period 2.47 years 4.00 years NOTE For Alpha: Out of total initial investment of 180,000, 50% will be spent in year-0 (90,000) and balance 50% will be spent in year-1 (90,000) Also, working capital of 20,000 will be spent in year-0 and will be recovered in year-4. As a result, 90,000 20,000 110,000 will be the cash outflow in year-0; In year-4, net cash flow will be 75,000 + residual value of 25,000 working capital of 20,000 120,000 (inflow)

For Beta: Along with initial investment of 260,000, working capital of 15,000 will be spent in year-0 and will be recovered in year-5. As a result, 260,000 + 15,000 = 275,000 will be the cash outflow in year-0; in year-5, net cash flow will be 35,000 + residual value of 12,000 + working capital of 15,000 62,000 (inflow) a-ii) NPV stands for Net Present Value and is calculated by subtracting initial investment amount from present value of future net cash flows discounted using cost of capital associated with the project. Discounting factor can be traced from discount factor table given. NPV rule says that a project with positive NPV shall be selected as it means that the project is capable of recovering all its cash outflows within life of the project itself even after considering time value of money Alpha Beta DF @ 10% Year a) x (b) (a) x (C 0 1.000 £110,000 -£110,000 £275,000 -£275,000 0.909 £25,000-£22,725 £90,000 E81,810 2 0.826 £85,000 £70,210 £80,000 £66,080 0.751 £106,000£79,606 £55,000 £41,305 4 0.683 £120,000 81,960 E50,000 £34,150 0.621 EO £62,000 £38,502 NPV £99,051 NPV -£13,153 b) Based on payback period, Alpha should be selected as its payback period is less than Beta's payback period; Based on NPV, Alpha should be selected as its NPV is positive whereas Beta's NPV is negative