The directors of Bonzo Ltd are currently considering two mutually exclusive investment projects. Both projects are concerned with the purchase of new plant. The following data are available for each project:

Project 1 (£) 2 (£)

Cost (immediate outlay) 100,000 60,000 Expected annual net profit (loss)

Year 1 29,000 18,000 2 (1,000) (2,000)

3 2,000 4,000 Estimated residual value 7,000 6,000 The company has an estimated cost of capital of 10 per cent and employs the straight-line method of depreciation for all fixed assets when calculating net profit. Neither project would increase the working capital of the company. The company has sufficient funds to meet all capital expenditure requirements.

Required

(a) Calculate for each project:

(i) the net present value;

(ii) the approximate internal rate of return;

(iii) the profitability index;

(iv) the payback period.

(b) State which, if any, of the two investment projects the directors of Mylo Ltd should accept, and why.

(c) State, in general terms, which method of investment appraisal you consider to be most appropriate for evaluating investment projects and why.

(Certified Diploma)