Question

As a financial manager of Xerox Enterprises, you are required to analyse two proposed capital investments, Projects A and B. Each has a cost of R100 000, and the cost of capital for each project is 12%. Depreciation on each project is estimated at R25 000 per year. The projects’ expected profit are as follows:

Project A Project B

Year

1 R40 000 R10 000

2 R5 000 R10 000

3 R5 000 R10 000

4 (R15 000) R10 000

Required
2.1 Calculate the payback period for each project (In years, months and days).
2.2 Calculate the NPV for each project.
2.3 Indicate with a reason which project should be chosen by Xerox Enterprises.
2.4 Calculate the ARR for project A.

Answer 1

Requirement 2.1:

PAYBACK PERIOD

Project A

Year	Cash Flow	Accumulated Cash Flow
1	R40,000 + R25,000 = R65,000	R65,000
2	R5,000 + R25,000 = R30,000	R95,000
3	R5,000 + R25,000 = R30,000	R125,000
4	(R15,000) + R25,000 = R10,000	R135,000

Year Cash Flow

1 R30,000 (R125,000 - R95,000)

? R5,000 (R100,000 - R95,000)

R5,000 / R30,000 = 0.167 Year

= 2 Years + 0.167 Year

= 2.167 Years

Payback period in Year = 2.167 Years Payback period in months = 2.167 Years * 12 months = 26.004 Months Payback period in days = 2.167 Years * 365 days = 790.955 days

Project B

Payback period = Initial Investment / Annual Cash flow

Annual Cash flow = R10,000 + R25,000 = R35,000

Payback Period = R100,000 / R35,000 = 2.857 years

Payback period in Year = 2.857 Years Payback period in months = 2.857 Years * 12 months = 34.284 Months Payback period in days = 2.857 Years * 365 days = 1,042.805 days

Requirement 2.2:

NET PRESENT VALUE

Net Present Value = Discounted cash inflow - Discounted cash outflow

Project A:

Year	Cash Flow	PVF @12%	Discounted Cash flow
1	R40,000 + R25,000 = R65,000	0.89286	R58,036
2	R5,000 + R25,000 = R30,000	0.79719	R23,916
3	R5,000 + R25,000 = R30,000	0.71178	R21,353
4	(R15,000) + R25,000 = R10,000	0.63552	R6,355
0	(R100,000)	1	(R100,000)
	Net Present value		R9,660

Project B:

Year	Cash Flow	PVF @12%	Discounted Cash flow
1 - 4	R10,000 + R25,000 = R35,000	3.03735	R106,307
0	(R100,000)	1	(R100,000)
	Net Present value		R6,307

Requirement 2.3:

Project A should be selected.

Because, Project A's Payback Period (2.167 Years) is less than the Project B's Payback period (2.857 Years) and Project A' NPV of R9,660 is greater than the Project B's NPV of R6,307.

Requirement 2.4:

Accounting Rate of return = Average net profit / Initial Investment * 100

Average Net Profit = (R40,000 + R5,000 + R5,000 - R15,000) / 4 = R8,750

Accounting rate of return = R8,750 / R100,000 * 100 = 8.75%

All the best...