For the following exercise, complete the calculations below. Evaluate different
ID: 2420708 • Letter: F
Question
For the following exercise, complete the calculations below. Evaluate different capital investment appraisal techniques by completing the calculations shown below:
Bongo Ltd. is considering the selection of one of two mutually exclusive projects. Both would involve purchasing machinery with an estimated useful life of 5 years.
Project 1 would generate annual cash flows (receipts less payments) of £200,000; the machinery would cost £556,000 with a scrap value of £56,000.
Project 2 would generate cash flows of £500,000 per annum; the machinery would cost £1,616,000 with a scrap value of £301,000.
Bongo uses straight-line depreciation. Its cost of capital is 15% per annum.
Assume that all cash flows arise on the anniversaries of the initial outlay, that there are no price changes over the project lives, and that accepting either project will have no impact on working capital requirements.
Assess the choice using the following methods by completing the calculations shown below:
ARR
NPV
IRR
Payback period
Calculate the missing answers:
ARR workings (Project 1)
These profits are the same each year in this question.
Annual depreciation (Cost – SV) / 5
Average NBV of investments
Be sure to demonstrate your workings.
Project 1 Project 2 ARR (see workings) 33% ??? NPV (£’000) ??? 210 IRR 25% ??? Payback Period (yrs) ??? 3.2Explanation / Answer
ARR of Project 2: NPV of Project 1 : Caluclating Accounting Profits: Net CashFlows : 200,000 Cash Flows: 500,000 PVAF @ 15% for 5 Yrs 3.3521 Less: Depreciation(WN:1) (263,000) PV of Cash In Flows 670,420 Accounting Profits 237,000 Scrap Value 56,000 Caluclating Average Investment: PV Factor @ 15% for 5th Year 0.4972 Average Investment = Intial Investment + Scrap Value Present Value of Cash Inflow 27,843 Average Investment = 16,16,000+301,000 Average Investment = 1,917,000 Total Inflows 698,263 Less: Initial Investment 556,000 ARR : Accounting Profits/ Average Investment NPV 142,263 ARR= 237000/1917000 ARR= 12.36% WN:1 Depreciation : (Cost-Scrap Value)/Life Depreciation : (16,16,000-301,000)/5 Depreciation is : 263,000 Caluclation of IRR for Project 2: Year NPV IRR Caluclation PV Factor @ 15% Cash Flow Present Value PV Factor @ 20% Present Value 0 1.00 (1,616,000) (1,616,000) 1 (1,616,000) 1 0.87 500,000 434,800 0.833 416,500 2 0.75 500,000 375,800 0.694 347,000 3 0.66 500,000 328,750 0.578 289,000 4 0.57 500,000 285,900 0.4822 241,100 5 0.50 500,000 248,600 0.401 200,500 5 0.50 301,000 149,657 0.401 120,701 NPV 207,507 (1,199) IRR - is the Rate at which NPV is Zero So IRR is 20.02 % (Approx) Profitability Index : Present Value of Future Cash Flows/ Intial Investment For Project 1: Payback Period is = Cost of Investment/ Annual Cash Inflows Payback Period is = 556000/500000 Payback Period is = 1.112 Profitability Index = 4,136/18,600 Profitability Index = 0.222