Question

Question 2:

Gandul Limited has the option to invest in Project XXX. The following information is available on the project:

   Project XXX :
Investment R280 000
Scrap value Nil
Expected life 5 years
Cost of capital   12%
Expected after tax profits and cash flows: Profits Cash Flows


End of: Rand Rand
Year 1 23 000 79 000
Year 2 26 000 82 000
Year 3 40 000 96 000
Year 4 43 000 99 000
Year 5 14 000 70 000

Required:
2.1 Calculate the accounting rate of return. (Two decimal places)   
2.2 Calculate the payback period. (In years, months and days)   
2.3 If the payback cut off is three years, should the project be chosen? Why?   
2.4 Calculate the net present value of the project. (Round off amounts to the nearest Rand.)
2.5 Should the project be accepted on the basis of NPV? Why

Answer 1

1.) Calculation of Accounting Rate of Return :

Accounting Rate of Return = Average Net Income / Initial Investment

Average Net Income = Sum of After Tax Profits / Number of years

= (23000 + 26000 + 40000+ 43000 + 14000) / 5

= 146000 / 5

= 29200

Accounting Rate of Return (Baed on Itial Investment) = 29200 / 280000

= 10.43%

2.) Calculation of Payback Period

Below is the table showing Cash Flow and Cumulative Cash Flows

Year	Cash Flows	Cumulative Cash Flows
1	79000	79000
2	82000	161000
3	96000	257000
4	99000	356000
5	70000	426000

Payback period

= Complete years + (initial Investment - Remaining cash flows) / Cash flow of the year to be recovered

=3 years + (280000 - 257000) / 99000

=3.23 years

3.) If the payback cut off is three years, the project should not be chosen as the payback perod exceeds the acceptable payback period.

4.) Calculation of Net Present value :

Year	Cash Inflow	Present Value Factor @12%	Present value of cash inflow
1	79000	0.892857143	70535.71429
2	82000	0.797193878	65369.89796
3	96000	0.711780248	68330.90379
4	99000	0.635518078	62916.28976
5	70000	0.567426856	39719.8799
		Total Present value of cash inflow	306872.6857
		Less : Cash outflow	280000
		Net Present Value	26873

2.5) The project should be accepted as it has positive NPV.