Windsor Limited are considering the possibility of investing in a new plant. The
ID: 2819272 • Letter: W
Question
Windsor Limited are considering the possibility of investing in a new plant. The following information has been extracted from the report to the project:
Cost of investment
400 000
Depreciation method
Straight-line
Residual value
Nil
Cost of capital
14%
Additional information
Year
Profit
Cash Flow
1
60 000
180 000
2
40 000
140 000
3
48 000
150 000
4
40 000
130 000
Required:
Calculate the following investment appraisal techniques:
Accounting rate of return
Payback period (in years, months and days)
Net present value
Cost of investment
400 000
Depreciation method
Straight-line
Residual value
Nil
Cost of capital
14%
Explanation / Answer
(i)
Average annual profit = Total profits/Number of years
= (60,000 + 40,000 + 48,000 + 40,000)/4
= 188,000/4
= $47,000
Average investment = Investment/2
= 400,000/2
= $200,000
Accounting rate of return = Average annual profit/Average investment
= 47,000/200,000
= 23.5%
(ii)
Payback period refers to the time in which initial investment in the project is recovered.
Payback period = A + B/C
where,
A = years full recovery
B = unrecovered cost at the begining of the last year
C = cash flows in the following year
Total cash flows in 2 years = $180,000 + 140,000
= $320,000
Cost of investment = $400,000
Hence, cash flows required in year 3 = 400,000 - 320,000
= $80,000
Payback perod = 2 + 80,000/150,000
= 2 + 0.53 years
= 2.53 years
= 2 years, 6 months and 12 days
(iii)
Calculation of Net present value
Net present value = Present value of cash inflows - Present value of cash outflows
= 443,730 - 400,000
= $43,730
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Year Cash flow PVF(14%, 4) Present value of cash inflows 1 180,000 0.877 157,860 2 140,000 0.769 107,660 3 150,000 0.675 101,250 4 130,000 0.592 76,960 $443,730Related Questions
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