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1. The following information relates to two possible capital projects of which you have to select one to invest in. Both projects have an initial

1. The following information relates to two possible capital projects of which you have to select one to invest in. Both projects have an initial cost of 500,000 and only one can be undertaken. Profit is calculated after deducting straight line depreciation. Project Y Expected Profits Years 1 150,000 80,000 2 150,000 110,000 3 80,000 180,000 4 40,000 230,000 Estimated resale value at end of Year 4 80,000 80,000 The cost of capital is 16%, relevant discount factors being as follows: End of Year 1 0.862 2 0.743 3 0.641 4 0.552 Required: a. Calculate the simple payback period for both projects, to one decimal place (6 marks). b. Calculate the Accounting Rate of Return (ARR) for both projects (10 marks). c. Calculate the Net Present Value (NPV) for both projects (20 marks). d. Advise the board which project in your opinion should be undertaken, giving reasons for your decision (2 marks). e. Explain what is meant by the term 'cost of capital', and why is it important in coming to an investment decision (2 marks). (Total: 40 marks)

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