Calculation of payback, NPV and ARR, and recommendation of which of two mutually exclusive projects should be accepted.

(a) Essential to an understanding of the investment appraisal techniques of payback, accounting rate of return and net present value is the role of depreciation.

Required:

Explain how you would treat depreciation in a computation for each of the above appraisal techniques giving reasons for your decisions.

(6 marks)

(b) Company TH Ltd is considering investing in one of two mutually exclusive projects. Both projects would require an investment of

£150 000 at the commencement of the project and the profile of returns is as follows:

You are told that the machinery associated with Project 1 will be sold for £70 000 at the end of year 4, and the machinery associated with project 2 will be sold for £30000 at the end of year 5.
The company’s cost of capital is 15%.

Required:
Clearly answer the manager’s query, identifying which investment appraisal technique, if any, utilizes the disposal proceeds of a capital investment at the end of a project.

Transcribed Image Text:

Project 1 Project 2 Profit Cash flow Profit Cash flow () () () () Year 140 000 60 000 30 000 54 000 Year 2 30 000 50 000 20 000 44 000 Year 3 25 000 45 000 15 000 39 000 Year 4 35 000 55 000 25 000 49 000 Year 5 50 000 74 000