Question

Question 5                                                                                                                         

The Fisheries Company Pty Ltd has two independent projects it could invest in to expand its fish breeding program. The financial operations manager has completed some analysis and has presented the information to the board. The board has asked you for advice.

The entity uses an Accounting Rate of Return of not accepting any project that returns less than 7% and a Payback Period criterion of not accepting any project that takes more than 7 years to recover costs.

	Project X	Project Y
Investment required ($'000)	800	1,400
Life of project (years)	10	15
Accounting Rate of Return	6.50%	7.50%
Payback period (years)	6	9
Net Present Value ($'000)	25	35

Required

1. Review each method and discuss whether it is acceptable to consider for the project.

   

2. Make an overall recommendation as to whether Fisheries should go ahead with Project X or Project Y, or neither. The Board is aware that the company is having trouble raising sufficient finance for the projects. Ensure you justify your decision.                                     

Answer 1

Answer 5)

a) 1) As per the Accounting Rate of Return method is considered Project X cannot be considered since the Accounting rate of return of project X is 6.50% which is less than 7% but on the other hand project Y can be accepted since the accounting rate of return of project Y is 7.50% which is more than 7%.

2)As per the Payback Period criterion is considered Project Y cannot be accepted because the payback period of project Y is 9 years which is more than 7 years but on the other hand project X can be accepted since the payback period of project X is 6 years which is less than 7 years.

3)As per the Net Present Value method is considered the net present value of Project Y is 35, which is more than the Net Present Value of Project X which is 25, so Project Y can be accepted.

b)Overall recommendation as per Accounting rate of return and Net Present Value method Fisheries should go ahead with Project Y as the Board is aware that the company is having trouble raising sufficient finance for the projects and as Project Y has higher NPV and as higher Net present value indicates that the projected earnings generated by a project exceed the anticipated costs.