Question

Enslin Clothing, a micro clothing manufacturing enterprise has the option to invest in machinery for projects M and N. However due to constraint financial resources the company may only be able to invest in one of them. You are given the following projected data:

	Project M (R)	Project N (R)
Investment	180 000	190 000
Net cash flows: Year 1	58 000	62 000
Year 2	63 000	62 000
Year 3	68 000	62 000
Year 4	72 000	62000
Year 5	51 000	62 000

Additional information:
1. Project M machinery will be disposed of at the end of year 5 with a scrap value of R20 000.
2. Project N machinery will be disposed of at the end of year 5 with a nil scrap value.
3. Depreciation is calculated on a straight line basis.
4. The discount rate to be used by the company is 12%.
Required:
5.1 Calculate the accounting rate of return for project M and N.
5.2 Calculate the payback period for project M.
5.3 Calculate the net present value of each project.
5.4 Using your answers from question 5.3 above, choose with reasons the most suitable project?
5.5 Calculate the internal rate of return for project N. (Use a discount rate above 17%)

Answer 1

Solution :-

To Calculate Average Accounting Rate of Return , We need to Deduct Depreciation From Net Cash flows .

Project M :-

Depreciation Per year = ( $180,000 - $20,000 ) / 5 = $32,000

Project N :-

Depreciation Per Year = $190,000 / 5 = $38,000

(ii)

(iii)

(iv) Most Suitable Project is Project M as it has Higher NPV and NPV is higher the Better

(v)

Therefore IRR of Project N - 18.90%

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