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Q56 The Elvira (Ghana) Limited contemplating three available investment opportunities, the cash flows of which are...
Q56
The Elvira (Ghana) Limited contemplating three available investment opportunities, the cash flows of which are given below
Initial Cash flow
Investment Year 1 Year 2 Year 3 Year 4 Year 5
GHS GHS GHS GHS GHS GHS
Project Adina (100) 40 40 40 40
Project Belcore (120) 10 10 10 10 200
Project Calisto (150) 100 80
In each case the initial investment represents the purchase of plant and machinery, whose realisable value will be 10% of initial cost, receivable in addition to the above flow at the end of the life of the project.
Required:
Advise the company on which project it should prefer, taking as your investment criterion the following alternative measures.
a) Payback period
b) Accounting rate of return (based on average investment)
c) Net present value at 15%
d) Internal rate of return
Solutions
Expert Solution
| Project Adina: | ||||||||||
| Year | Cash Flow | Cumulative cash flow | PVIF at 15% | PV at 15% | PVIF at 25% | PVIF at 25% | PVIF at 24% | PV at 24% | Annual Income | |
| 0 | -100.00 | -100.00 | 1 | -100.00 | 1 | -100.00 | 1 | -100.00 | ||
| 1 | 40.00 | -60.00 | 0.86957 | 34.78 | 0.80000 | 32.00 | 0.80645 | 32.26 | 17.50 | |
| 2 | 40.00 | -20.00 | 0.75614 | 30.25 | 0.64000 | 25.60 | 0.65036 | 26.01 | 17.50 | |
| 3 | 40.00 | 20.00 | 0.65752 | 26.30 | 0.51200 | 20.48 | 0.52449 | 20.98 | 17.50 | |
| 4 | 50.00 | 70.00 | 0.57175 | 28.59 | 0.40960 | 20.48 | 0.42297 | 21.15 | 17.50 | |
| 19.92 | -1.44 | 0.40 | 70.00 | |||||||
| Payback = 100/40 = | 2.50 | Years | ||||||||
| ARR = Average annual income/Average investment = (70/4)/((100+10)/2) = | 31.82% | |||||||||
| NPV = | 19.92 | |||||||||
| IRR = 24%+1%*0.40/(1.44+0.40) = | 24.22% | |||||||||
| Project Belcore: | ||||||||||
| Year | Cash Flow | Cumulative cash flow | PVIF at 15% | PV at 15% | PVIF at 17% | PVIF at 17% | PVIF at 18% | PV at 18% | Annual Income | |
| 0 | -120.00 | -120.00 | 1 | -120.00 | 1 | -120.00 | 1 | -120.00 | ||
| 1 | 10.00 | -110.00 | 0.86957 | 8.70 | 0.85470 | 8.55 | 0.84746 | 8.47 | -11.60 | |
| 2 | 10.00 | -100.00 | 0.75614 | 7.56 | 0.73051 | 7.31 | 0.71818 | 7.18 | -11.60 | |
| 3 | 10.00 | -90.00 | 0.65752 | 6.58 | 0.62437 | 6.24 | 0.60863 | 6.09 | -11.60 | |
| 4 | 10.00 | -80.00 | 0.57175 | 5.72 | 0.53365 | 5.34 | 0.51579 | 5.16 | -11.60 | |
| 5 | 212.00 | 132.00 | 0.49718 | 105.40 | 0.45611 | 96.70 | 0.43711 | 92.67 | 178.40 | |
| 13.95 | 4.13 | -0.43 | 132.00 | |||||||
| Payback period = 4+80/212 = | 4.38 | Years | ||||||||
| ARR = Average annual income/Average investment = (132/5)/((120+12)/2) = | 40.00% | |||||||||
| NPV = | 13.95 | |||||||||
| IRR = 17%+1%*0.43/(4.13+0.43) = | 17.09% | |||||||||
| Project Calisto: | ||||||||||
| Year | Cash Flow | Cumulative cash flow | PVIF at 15% | PV at 15% | PVIF at 20% | PVIF at 20% | PVIF at 19% | PV at 19% | Annual Income | |
| 0 | -150.00 | -150.00 | 1 | -150.00 | 1 | -150.00 | 1 | -150.00 | ||
| 1 | 100.00 | -50.00 | 0.86957 | 86.96 | 0.83333 | 83.33 | 0.84034 | 84.03 | 32.50 | |
| 2 | 95.00 | 45.00 | 0.75614 | 71.83 | 0.66667 | 63.33 | 0.70616 | 67.09 | 57.50 | |
| 8.79 | -3.33 | 1.12 | 90.00 | |||||||
| Payback period = 1+50/95 = | 1.53 | Years | ||||||||
| ARR = 45/((150+15)/2) = | 54.55% | |||||||||
| NPV | 8.79 | |||||||||
| IRR = 19%+1%*1.12/(1.12+3.33) = | 19.25% | |||||||||
| The results of the four measures are tabulated below: | ||||||||||
| Adina | Belcore | Calisto | ||||||||
| a] | Payback period in years | 2.50 | 4.38 | 1.53 | ||||||
| b] | ARR | 31.82% | 40.00% | 54.55% | ||||||
| c] | NPV |
19.92
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