Question

1. Calculation of Payback, NPV and ROI (20p)

Brewing House Ab is organized into divisions. For operating purposes, each division is regarded as an investment centre, with divisional managers enjoying substantial autonomy in their selection of investment projects. Divisional managers are rewarded via a remuneration package which is linked to a Return on Investment (ROI) performance measure. The ROI calculation is based on the net book value of assets at the beginning of the year. Although there is a high degree of autonomy in investment selection, an approval to go ahead must be obtained from group management at the head office in order to release the finance.

Divisions A, B and C are currently investigating three independent investment proposals (one project in each division). Group finance staff assess the cost of capital to the company at 12 per cent. Ignore tax and residual values. Depreciation is straight-line over asset life, which is 5 years in each case.

The details of the three proposals are:

	Project Division A (1.000€)	Project Division B (1.000€)	Project Division C (1.000€)
Initial cash outlay on fixed assets	75	75	75
Net cash inflow in year 1	15	40	5
Net cash inflow in year 2	15	30	20
Net cash inflow in year 3	15	20	20
Net cash inflow in year 4	15	10	30
Net cash inflow in year 5	15	0	4

Calculate the following for all three projects (A, B and C):

1. Payback period (3p)
2. NPV (9p)
3. ROI (3p)
4. Briefly explain which of the projects should be accepted by the company management if there are resources to accept only one project

Answer 1