Investments (20) INVESTMENT CRITERIA QUESTION 5 REQUIRED y the information given
ID: 2817999 • Letter: I
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Investments
(20) INVESTMENT CRITERIA QUESTION 5 REQUIRED y the information given below and calculate the following: 1 Payback Period of both projects. (Answers must be expressed in years, months and days.) Which project would you choose on the basis of payback period? Why? 52 Accounting Rate of Return (on average investment) of Project X (answer rounded off to 2 decimal places). 53 Net Present Value of both projects. (Round off amounts to the nearest Rand.) 5.4 Benefit Cost Ratio for Project X (answer rounded off to 2 decimal places). INFORMATION The following information relates to two projects that are being evaluated by FCB Limited: Project X R250 000 5 years Project Y R250 000 5 years Initial cost Expected life Expected scrap value Average annual profit Expected net cash inflows End of year 1 2 R27 000 R25 000 85 000 95000 80 000 75 000 50 000 75 000 75 000 75 000 75 000 75 000 Th e company estimates its cost of capital is 12%.Explanation / Answer
5.1)
Project X:
Cumulative cash flow for year 0 = -250,000
Cumulative cash flow for year 1 = -250,000 + 85,000 = -165,000
Cumulative cash flow for year 2 = -165,000 + 95,000 = -70,000
Cumulative cash flow for year 3 = -70,000 + 80,000 = 10,000
70,000 / 80,000 = 0.875
Payback period = 2 + 0.875 = 2.875 or 2 years 8 months and 75 days
Project Y:
Cumulative cash flow for year 0 = -250,000
Cumulative cash flow for year 1 = -250,000 + 75,000 = -175,000
Cumulative cash flow for year 2 = -175,000 + 75,000 = -100,000
Cumulative cash flow for year 3 = -100,000 + 75,000 = -25,000
Cumulative cash flow for year 4 = -25,000 + 75,000 = 50,000
25,000 / 75,000 = 0.333
Payback period = 3 + 0.33 = 3.33 or 3 years 3 months and 33 days
5.2)
Project X:
Accounting rate of return = Net income / ( initial investment - book value) / 2
Accounting rate of return = 27,000 / ( 250,000 - 0)/2
Accounting rate of return = 27,000 / 125,000
Accounting rate of return = 0.216 or 21.6%
Project Y:
Accounting rate of return = Net income / ( initial investment - book value) / 2
Accounting rate of return = 25,000 / ( 250,000 - 0)/2
Accounting rate of return = 25,000 / 125,000
Accounting rate of return = 0.20 or 20%
5.3)
Net Present Value = Present value of cash inflow - present value of cash outflows
Project X:
Net Present Value = -250,000 + 85,000 / ( 1 + 0.12)1 + 95,000 / ( 1 + 0.12)2 + 80,000 / ( 1 + 0.12)3 + 75,000 / ( 1 + 0.12)4 + 50,000 / ( 1 + 0.12)5
Net Present Value = -250,000 + 284,603.89
Net Present Value = $34,603.89
Project Y:
Net Present Value = -250,000 + 75,000 / ( 1 + 0.12)1 + 75,000 / ( 1 + 0.12)2 + 75,000 / ( 1 + 0.12)3 + 75,000 / ( 1 + 0.12)4 + 75,000 / ( 1 + 0.12)5
Net Present Value = -250,000 + 270,358.22
Net Present Value = $20,358.22
5.4)
Benefit to cost ratio = Present value of cash flows / initial investment
Project X:
Benefit to cost ratio = 284,603.89 / 250,000
Benefit to cost ratio = 1.1384
Project Y:
Benefit to cost ratio = 270,358.22 / 250,000
Benefit to cost ratio = 1.0814
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