Question

Question 1 Conan Engineering has three departments. The company has £1,650,000 available for investments and each department has been asked to identify a project that is suitable for investment. Only ONE department will be given £1,650,000 to invest. Project cash flow forecasts. The forecasts are for a 5 year period. Department Alpha Department Beta Department Delta Year 1 £540,000 £210,000 £940,000 Year 2 £490,000 £230,000 £740,000 Year 3 £490,000 £470,000 £230,000 Year 4 £450,000 £920,000 £120,000 Year 5 £450,000 £940,000 £80,000 NPV -£6,723 £8,913 -£13,449 For all departments cash flows exclude depreciation. The required rate of return has been estimated at 15%. The investment base for Return on Investment (ROI) and Residual Income (RI) calculations is net book value (written-down value) of the investment at the beginning of the year. Straight line depreciation is applied at the rate of 20% Required: i. Calculate the ROI and RI for the three departments over the five-year period. Compare the ROI, RI and NPV for the three departments. Which department should be given the £1,650,000 to invest? ii. Economic Value Added (EVA) is another technique that Conan Engineering has considered. Discuss why EVA may not be regularly used by companie

Answer 1

	Return on Investment
					Amount in £
		Cash Flow Fore Cast
		Year	Alpha	Beta	Delta
		1	540,000	210,000	940,000
		2	490,000	230,000	740,000
		3	490,000	470,000	230,000
		4	450,000	920,000	120,000
		5	450,000	940,000	80,000
	Total		2,420,000	2,770,000	2,110,000
	Less:Depreciation for 5 year		(1,650,000)	(1,650,000)	(1,650,000)
	Net Profit		770,000	1,120,000	460,000
	Investment		1,650,000	1,650,000	1,650,000
	Return on Investment		47%	68%	28%
	Investment		1,650,000
	Depreciation p.a		330,000
	Residual Income
					Amount in £
		Cash Flow Fore Cast
		Year	Alpha	Beta	Delta
		1	540,000	210,000	940,000
		2	490,000	230,000	740,000
		3	490,000	470,000	230,000
		4	450,000	920,000	120,000
		5	450,000	940,000	80,000
	Total		2,420,000	2,770,000	2,110,000
	Less:Depreciation for 5 year		(1,650,000)	(1,650,000)	(1,650,000)
	Net Profit		770,000	1,120,000	460,000
	Less Interest(1650000*15%)		(247,500)	(247,500)	(247,500)
	Residual Income		522,500	872,500	212,500
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