Bongo Ltd. is considering the selection of one of two mutually exclusive project
ID: 2421069 • Letter: B
Question
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
Cash Flow 5,00,000
Depreciation 2,63,000
Accounting Profit 2,37,000
Annual depreciation= (16,16,000-3,01,000)/5=2,63,000
Average NBV of Investment= 16,16,000+3,01,000/2
9,58,500
ARR= 2,37,000/9,58,500
24.73%
NPV of Project-1 is
Cash Outlfow= 5,56,000-(56,000*0.4972)
=528157
Cash Inflow= 2,00,000*3.3522
=6,70,440
NPV=670-528
=142
IRR of Project-2=IRR= 20% at which NPV becomes Zero
Payback Period of Project -1
=556000/200000
=2.78