Question

Bulangililo Investments (BI) has obtained a loan of K310,000 at 15% pa to invest in the latest model of a machine, with an expected life span of 4 years at the end of which the salvage value will be K10,000. The project will generate the following as in the table below: Year 0 1 2 3 4 K’000 K’000 K’000 K’000 K’000 Investment 310 Sales 205 346 502 574 Project expenses (Note 1) 123 176 378 426 Taxable profit 82 170 128 148 Taxation 29 60 45 52 Profit after tax 53 110 83 96 All the above estimates have been prepared in terms of present-day costs and prices. The following additional information is available to you: Capital allowances (tax depreciation) are allowable for tax purposes against profits at 25% per year on a straight-line basis Taxation on profits is at 35% The company’s after-tax cost of capital is 10% per year. Assume that all receipts and payments arise at the end of the year to which they relate except those in year 0 which occur immediately. Note 1 The above expenses include the following:

Required (a) Calculate the accounting rate of return if the target accounting rate of return is 15%

(b) Use the information above to determine whether the project is viable using the NPV.

Answer 1

Since NPV of the project is positive, therefore it is viable

Discount Rate used here will be Cost of Capital (Post Tax) of company not post tax interest rate of loan used to fund the project

Because this is the return which the company wants to earn on all of its projects

Also If it earns same amount which it is paying as interest there's no point of getting involved in the project