Question

QUESTION 5 Note: Where applicable, use the present value tables provided in APPENDICES 1 and 2 that appear after


REQUIRED Use the information given below to calculate the following:


5.1 Payback Period of both projects (answers expressed in years and months).

5.2 Accounting Rate of Return of Project A (answer expressed to two decimal places).

5.3 Net Present Value (NPV) of both projects (amounts rounded off to the nearest Rand).

5.4 Profitability Index of Project B (answer expressed to two decimal places).

5.5 Internal Rate of Return of Project B (answer expressed to two decimal places).


INFORMATION Gentry Ltd had to choose between these two projects, Project A or Project B, for which the following net cash inflows have been forecasted:

Year 1 2 3 4
Project A R60 000 R160 000 R200 000 R360 000
Project B R172 000 R172 000 R172 000 R172 000
  

Project A requires an investment of R560 000 while project Project B requires an investment of R500 000. The average annual profit of projects Project A and Project B are expected to be R55 000 and R47 000 respectively. Both projects are expected to have no salvage value. The minimum required rate of return on these projects is 12%.

Answer 1

5.1 - Payback period

Project A

Capital outlay (in USD)

560,000

Cash inflows table

Year	1	2	3	4
Cash inflows (in USD)	60,000	160,000	200,000	360,000
Cumulative cashinflows	60,000	220,000	420,000	780,000

Step 1 : Monthly cash inflows for 4th year	30,000.00
Step 2 : Additional cashflow required - post year 3 to reap the initial cash outlay (Initial capital outlay - cumulative cashflows as on Year 3)	140,000
No. of months to get cashflows of USD 140,000 in year 4 (Additional cashflow required / monthly cashflows for Year 4)	4.67
Rounding off to next month	5

Therefore payback period for Project A is 3 years 5 months

Project B

Capital outlay (in USD)

500,000

Cash inflows table

Year	1	2	3	4
Cash inflows (in USD)	172,000	172,000	172,000	172,000
Cumulative cashinflows	172,000	344,000	516,000	688,000

Step 1 : Monthly cash inflows for 3rd year	14,333.33
Step 2 : Additional cashflow required - post year 2 to reap the initial cash outlay (Initial capital outlay - cumulative cashflows as on Year 2)	156,000
No. of months to get cashflows of USD 156,000 in year 3 (Additional cashflow required / monthly cashflows for Year 3)	10.88
Rounding off to next month	11

Therefore payback period for Project B is 2 years 11 months

5.2 Accounting Rate of Return of Project A

Computation of Average Investment

Details	Project A	Project B
Value of investment at year 0	560,000.00	500,000.00
Value of investment at year 4 (no salvage value)	-	-
Average Investment -- >(Investment at year 0 + Investment at Year 4)/2	280,000.00	250,000.00

Computation of Accounting rate of return

Details	Project A	Project B
Average annual profits	55,000.00	47,000.00
Average Investment (refer above table)	280,000.00	250,000.00
Accounting rate of return ----> (Average annual profits / Average investment) *100	19.64%	18.80%

5.3 Net Present Value (NPV)

Project A

Cashflow table

Year	0	1	2	3	4
Investment	(560,000.00)
Annual cashflows		60,000.00	160,000.00	200,000.00	360,000.00
Net cashflows	(560,000.00)	60,000.00	160,000.00	200,000.00	360,000.00
PV factor @ 12%	1.0000	0.8929	0.7972	0.7118	0.6355
PV of cashflows	(560,000.00)	53,571.43	127,551.02	142,356.05	228,786.51
NPV	(7,735)

Project B

Cashflow table

Year	0	1	2	3	4
Investment	(500,000.00)
Annual cashflows		172,000.00	172,000.00	172,000.00	172,000.00
Net cashflows	(500,000.00)	172,000.00	172,000.00	172,000.00	172,000.00
PV factor @ 12%	1.0000	0.8929	0.7972	0.7118	0.6355
PV of cashflows	(500,000.00)	153,571.43	137,117.35	122,426.20	109,309.11
NPV	22,424

5.4 Profitability Index of Project B

Year	1	2	3	4
Annual cashflows	172,000.00	172,000.00	172,000.00	172,000.00
Net cashflows	172,000.00	172,000.00	172,000.00	172,000.00
PV factor @ 12%	0.8929	0.7972	0.7118	0.6355
PV of cashflows	153,571.43	137,117.35	122,426.20	109,309.11
Present value of future cashflows	522,424

Present value of future cashflows	522,424
Initial investment	500,000
Profitability Index ---> (Present value of future cashflows / Initial investment)	1.04

5.5 Internal Rate of Return of Project B

NPV @ 12%

Year	0	1	2	3	4
Investment	(500,000.00)
Annual cashflows		172,000.00	172,000.00	172,000.00	172,000.00
Net cashflows	(500,000.00)	172,000.00	172,000.00	172,000.00	172,000.00
PV factor @ 12%	1.0000	0.8929	0.7972	0.7118	0.6355
PV of cashflows	(500,000.00)	153,571.43	137,117.35	122,426.20	109,309.11
NPV	22,424

NPV @ 15%

Year	0	1	2	3	4
Investment	(500,000.00)
Annual cashflows		172,000.00	172,000.00	172,000.00	172,000.00
Net cashflows	(500,000.00)	172,000.00	172,000.00	172,000.00	172,000.00
PV factor @ 15% ---> Formula --> 1/(1+15%)^nth year	1.0000	0.8696	0.7561	0.6575	0.5718
PV of cashflows	(500,000.00)	149,565.22	130,056.71	113,092.79	98,341.56
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