Question

Tega Limited has just made an investment of R390 000 in a new machine. Details of the machine are as follows:
 Expected useful life 5 years (straight line depreciation)
 Salvage value 10 000 (sold as scrap metal)
 Cost of capital 10 %
 The tax rate is 30%
 Expected cash flows are as follows:

Required:
4.1 Calculate the Payback Period. (5)
4.2 Determine the Accounting / Average Rate of Return (ARR). (5)
4.3 Tega Limited requires a payback period of no more than 4 years and a return of at least 25%. On the basis of these criteria, should this project be accepted? Explain your answer. (4)
4.4 Calculate the Net Present Value for the project. Should the project be accepted on this basis? Explain your answer. (7)
4.5 To make your ultimate decision, which method will you choose? Why? (4)

Year
1 80 000
2 120 000
3 100 000
4 110 000
5 90 000

Answer 1

Question No:4.1:

Payback Period = 4 + (390000-378200)/95800 = 4.12 Years

Question No:4.2:

Average Rate of Return = (474,000-390,000)/5/390000 *100 = 4.31%

Question No:4.3:

Return on Investment = (474,000-390,000)/390000 *100 = 21.54%

The Payback Period of the Project is more than 4 Years and the return on Investment is 21.54%, which is less than required rate of return i.e. 25%; hence, the project shall not be accepted.

Question No:4.4:

Project shall be accepted, if NPV of the Project is greater than "0".

The NPV of the Project is -32,728; hence the Project shall not be accepted

Question No. 4.5:

The ultimate decision is not to accept the project based on NPV, because NPV method considers the Time Value of the money invested in the Project.