Question

Canny Construction is looking to invest in new construction equipment. The following information has been extracted from reports relating to the project

Investment R90 000

Average Annual Profit R 26 667

Life span 3 YEARS

Minimum required rate of return 10 %

Cash flow:   

1st Year R90 000

2nd Year R400 000

3rd Year R110 000

Required

2.1 Calculate the accounting rate of return on average investment

2.2 Calculate the payback period (Answer in years, months, and days).

2.3 Calculate the Net Present Value ( Round off amounts to the nearest Rand)

2.4 Would the project be acceptable at a cost of capital of 12%? Motivate your answer with an appropriate calculation that takes into consideration the time value of money

Answer 1

2.1)Accounting rate of return= Average annual profit /Average investment

                             = 26667/45000

                             = .5926 or 59.26%

working:

Average investment =[Beginning book value +ending book value]/2

                = [90000+0]/2

                = 45000

2.2)

Year	cash flow	Cumulative cash flow
0	-90000	-90000
1	90000	-90000+90000=0
2	400000	0+400000=400000
3	110000	400000+110000= 510000

payback period= year up to which cumulative cash flow is negative + (cumulative cash flow of that year /cash flow of immediate next year]

                    = 0+ (90000/90000)

                    = 0 +1

                    = 1 year

c)

Year	cash flow	present value factor at 10%	cash flow *present value factor
0	-90000	1	-90000
1	90000	.90909	81818.1
2	400000	.82645	330580
3	110000	.75131	82644.1
Net present value			405042.2 (rounded to 405042)

#Find present value factor using the formula 1/(1+i)^n   where i= 10% and n=1,2,3 or from present value table

2.4)

Year	cash flow	present value factor at 12%	cash flow *present value factor
0	-90000	1	-90000
1	90000	.89286	80357.4
2	400000	.79719	318876
3	110000	.71178	78295.8
Net present value			387529.20 (rounded to 387529)

since Net present value is positive at 12% ,project should be accepted.