Question

Gandul Limited has the option to invest in Project XXX. The following information is available on the project: Project XXX Investment R280 000 Scrap value Nil Expected life 5 years Cost of capital 12% Expected after tax profits and cash flows Profits Cash flows End of: Rand Rand Year 1 23 000 79 000 Year 2 26 000 82 000 Year 3 40 000 96 000 Year 4 43 000 99 000 Year 5 14 000 70 000 Required: 2.1 Calculate the accounting rate of return. (Two decimal places) (4) 2.2 Calculate the payback period. (In years, months and days) (4) 2.3 If the payback cut off is three years, should the project be chosen? Why? (2) 2.4 Calculate the net present value of the project. (Round off amounts to the nearest Rand.) (8) 2.5 Should the project be accepted on the basis of NPV? Why? (2)

Answer 1

Answer to Part 2.1:

Average Annual Net Income = (23,000 + 26,000 + 40,000 + 43,000 + 14,000) / 5
Average Annual Net Income = 29,200

Accounting Rate of Return = Average Annual Net Income / Initial Investment
Accounting Rate of Return = 29,200 / 280,000
Accounting Rate of Return = 0.1043 or 10.43%

Answer to Part 2.2:

Payback Period = 3 years + 23,000 / 99,000
Payback Period = 3.23 years

Answer to Part 2.3:

No, as the Project's payback period is more than cut off payback period.

Answer to Part 2.4:

NPV = PV of Cash Inflow - Initial Investment
NPV = 306,875 - 280,000
NPV = 26,875

Answer to Part 2.5

Yes, as Project's NPV is positive.