Smith Ltd is considering whether to undertake one of twomutually exclusive proje

Question

Smith Ltd is considering whether to undertake one of twomutually exclusive projects, each of which would require thepurchase of an asset costing £100,000. Both projects wouldhave a zero scrap value at the end of four years. The cash flowsassociated with the two projects are as follows:       Project A Project B       £   £ Initial investment 100,000 100,000
Net cash inflows: Year 1    20,000 50,000 Year 2    80,000 40,000 Year 3    10,000 50,000 Year 4    40,000 10,000
Required a) Calculate the (non-discounted) Payback Period for Project Aand Project B.
b) Calculate the Accounting Rate of Return (ARR) for Project Aand Project B.
c) Calculate the Net Present Value (NPV) for Project A andProject B using a discount rate of 8%.
d) Based on your calculations in parts a), b) and c) advisethe management of Smith Ltd. on the preferred project to investin.
Smith Ltd is considering whether to undertake one of twomutually exclusive projects, each of which would require thepurchase of an asset costing £100,000. Both projects wouldhave a zero scrap value at the end of four years. The cash flowsassociated with the two projects are as follows:       Project A Project B       £   £ Initial investment 100,000 100,000
Net cash inflows: Year 1    20,000 50,000 Year 2    80,000 40,000 Year 3    10,000 50,000 Year 4    40,000 10,000
Required a) Calculate the (non-discounted) Payback Period for Project Aand Project B.
b) Calculate the Accounting Rate of Return (ARR) for Project Aand Project B.
c) Calculate the Net Present Value (NPV) for Project A andProject B using a discount rate of 8%.
d) Based on your calculations in parts a), b) and c) advisethe management of Smith Ltd. on the preferred project to investin.

Explanation / Answer

Project A End of Cash Flows Present Value factors Present Value Today -100,000 1 -100,000 Year 1 20,000 0.93 18,519 Year 2 80,000 0.86 68,587 Year 3 10,000 0.79 7,938 Year 4 40,000 0.74 29,401 Net Present Value 24,445 Project B End of Cash Flows Present Value factors Present Value Today -100,000 1 -100,000 Year 1 50,000 0.93 46,296 Year 2 40,000 0.86 34,294 Year 3 50,000 0.79 39,692 Year 4 10,000 0.74 7,350 Net Present Value 27,632 ARR Project A Year Return Total Return Rate of Return 1 20,000 2 80,000 3 10,000 4 40,000 150,000 150.00% Project B Year Return Total Return Rate of Return 1 50,000 2 40,000 3 50,000 4 10,000 150,000 150.00% From ARR, both the return are same. However from theNPV calculation, NPV of project B is more value than project A.This show that money invest in project B give more value. Paybackperiod of B is just 0.2 hours more than period A. I think that itis more valuable invest in B

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