The finance manager of Willow plc is evaluating two mutually exclusive projects with the following cash flows.

Willow’s cost of capital is 10 per cent and both investment projects have zero scrap value. The company’s current return on capital employed is 12 per cent (average investment basis) and the company uses straight-line depreciation over the life of projects.

(a) Advise the company which project should be undertaken in the following circumstances if:
(i) the net present value method of investment appraisal is used;
(ii) the internal rate of return method of investment appraisal is used;
(iii) the return on capital employed method of investment appraisal is used.

(b) Discuss the problems that arise for the net present value method of investment appraisal when capital is limited, and explain how such problems may be resolved in practice.

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Year Project A Project B () () 0 (110 000) (200 000) 1 45 000 50 000 2345 45 000 50 000 30 000 50 000 30 000 100 000 20 000 55 000