Question

QUESTION 2

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

sales revenue(150000*12)	1800000
less: variable costs	225000
less: fixed costs	750000
less: depreciation expense	500000
net income	325000
add: depreciation	500000
annual cashinflow	825000

2.1 Net Present Value = Present value of cash inflow - initial investment

= 825000*3.35216-2500000 = $265532

2.2 Accounting Rate of Return on average investment = average net income / average investment

= 325000/(2500000+0)/2

= 26%

2.3 Cumulative present value factor = initial investment/ annual cash inflow

= 2500000/825000 = 3.0303

Internal Rate of Return = 19.40%