Question

QUESTION ONE Caltex Ltd (Oil Company) sets a hurdle rate of 14% per annum for evaluating investment proposals. It is looking at purchasing new automated coffee machines to be installed in several convenience stores located on their service station sites. Currently, it is considering three competing proposals and does not have sufficient funds to finance all three. Details of the proposals, all of which will cover a five-year term, are given below: A B C Investment cost $1,000,000 $500,000 $250,000 Estimated annual net cash inflow / savings - pa $300,000 $200,000 $175,000 Additional information: a) The present value of $1, ie. (1+r)-n Where: r = discount rate; n = number of periods until payment. Discount rate (r) 14% Periods (n) 1 2 3 4 5 Present value of $1 0.877 0.769 0.675 0.592 0.519 b) The coffee machines for accounting purposes are totally depreciated under straight-line depreciation over their useful life of five years c) (Note: Ignore Tax Implications and assume estimated annual net cash inflow / savings are gained at year end each year) REQUIRED (a) Calculate the Accounting Rate of Return, Payback Period and the Net Present Value ( or Cost) of each of the three proposals. (b) In your own words interpret the meaning of the results from each investment appraisal technique calculated in (a) above and rank the 3 investment proposals in order, nominating which investment you would accept or reject, justifying your answer. (60 words limit) (c) The manager at Caltex Ltd says she has heard that the data used in NPV calculations can be unreliable, especially estimates of future cash flows, and that alternative methods of assessing a capital investment would be more reliable. Discuss in your own words the limitations and advantages of NPV analysis over other alternative capital evaluation techniques reviewed throughout the semester. (180 words limit).

Answer 1