Question

InWealth is a profitable company maximising its resources by investing into profitable projects. InWealth is now considering two investment projects as follows:
The cash flows for each project are given in the table below:
		Project A123	Project B789
	Initial cost (paid immediately)	$500,000	$500,000
	Net cash flow for year 1	$ 50,000	$250,000
	Net cash flow for year 2	$ 80,000	$200,000
	Net cash flow for year 3	$100,000	$200,000
	Net cash flow for year 4	$600,000	$130,000
Assume all cash flows are received at the end of the relevant year. Both projects will have no salvage value after the 4th year.
InWealth uses a discount rate of 10.25% per annum for the projects.
Required:
Calculate the Accounting Rate of Return (ARR) for both projects (a) Calculate the Payback Periods (PP) for both projects. (b) Calculate the Net Present Values (NPV) for both projects. (c)Calculate the Profitability Index (PI) for both projects. (d) Which of the two projects should be accepted and why? (e) State two assumptions made in using the NPV analysis technique.

Answer 1

First 4 requirements(ARR, PP, NPV,PI) are solved.

. ARR= Average net income​ / Initial Investment

		Project A123	Project B789
a	Initial cost	$500,000	$500,000
b	Net cash flow for year 1	$50,000	$250,000
c	Net cash flow for year 2	$80,000	$200,000
d	Net cash flow for year 3	$100,000	$200,000
e	Net cash flow for year 4	$600,000	$130,000
f	Average Annual Cash inflow{b+c+d+e)/4}	$207,500	$195,000
	ARR= f/a	41.50%	39.00%

Payback Periods (PP

NPV AND PI