Question

INFORMATION
Medico Limited intends investing in a project during March 2021.

The project is expected to cost R2 500 000 with a five-year useful life, and no residual value.

The annual volume of production for the project is estimated at 150 000 units, which can be sold for cash at R12 per unit.

Depreciation is expected to be R500 000 per year. Annual cash operating costs are as follows:

Variable costs
R225 000

Fixed costs
R750 000

The cost of capital is 15%.

REQUIRED
Use the information provided above to calculate the following:
2.1 Net Present Value
2.2 Accounting Rate of Return on average investment (answer expressed to two decimal places)
2.3 Internal Rate of Return, if the net cash flows are R720 000 per year for five years (answer expressed to two decimal places).

Answer 1

MEDICO LIMITED INTEND -

CALCULATION OF NPV -

NPV = SUM OF DISCOUNTED CASH FLOW - SUM OF DISCOUNTED CASH OUTFLOW

CALCULATION OF SUM OF DISCOUNTED CASH INFLOW = (SALES VALUE - VARIBLE COST - FIXED COST)

=(150,000*12)-225,000-750,000 = 825000

CALCULATION OF ACCOUNTING RATE OF RETURN

AVERAGE INVESTMENT = BOOK VALUE AT THE BEGINNING OF YEAR + BOOK VALUE AT THE END OF THE YEAR / 2

2500000/2 = 12,50,000

ARR= AVERAGE ANNUAL NET INCOME / AVG INVESTMENT *100

2500000/2 *100 = 66%

CALCULATION OF IRR IF NET CASH FLOW R720,000 PER YEAR  

IRR = SUM OF DISCOUNTED CASH INFLOW = INITIAL INVESTMENT

720,000*PV AF@X%5 YEARS = 2500,000

X = 2500,000/720,000 = 3.472