Question

Onta Enterprises is seeking to expand operations and is considering increasing production capacity by purchasing the latest plant and equipment.  The following two plants are being considered for acquisition as they are technically superior to the current plant and will enable higher production volumes with lower cost inputs.  The finance department has projected the cash flows for the life of the plant and has asked you as the investment manager to advise the Board on which of these plants to acquire. Onta’s current cost of capital is 12%.

The following information relates to the two plants that are being considered:

	Plant Alpha	Plant Beta
Initial cost	R550 000	R 400 000
Expected useful life	4 years	4 years
Depreciation	R137 500 p.a.	R100 000 p.a.
	Net cash inflows	Net cash inflows	Net profit
Expected net cash inflows	R	R	R
1st year 2nd year 3rd year 4th year	180 000 190 000 210 000 160 000	130 000 130 000 130 000 130 000	30 000 30 000 30 000 30 000

Calculate the:

2.1       Payback Period for both plants.  (Answers must be expressed in years, months and days.)                                                                                                                                                          (6)

2.2       Accounting Rate of Return for Plant Beta on initial investment.                                            (4)

2.3       Net Present Value of each plant. (Round off amounts to the nearest Rand.)                       (9)

2.4       Based on your results in 2.1.3 which plant should be accepted?                                         (1)

Answer 1