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Conan Engineering has three departments. The company has 1,650,000 available for investments and each department has been asked to identify a project that is suitable
Conan Engineering has three departments. The company has 1,650,000 available for investments and each department has been asked to identify a project that is suitable for investment. Only ONE department will be given 1,650,000 to invest. Project cash flow forecasts. The forecasts are for a 5 year period. Department Department Department Alpha Beta Delta Year 1 540,000 210,000 940,000 Year 2 490,000 230,000 740,000 Year 3 490,000 470,000 230,000 Year 4 450,000 920,000 120,000 Year 5 450,000 940,000 80,000 NPV -6,723 8,913 -13,449 For all departments cash flows exclude depreciation. The required rate of return has been estimated at 15%. The investment base for Return on Investment (ROI) and Residual Income (RI) calculations is net book value (written-down value) of the investment at the beginning of the year. Straight line depreciation is applied at the rate of 20% Required: i. Calculate the ROI and RI for the three departments over the five-year period. Compare the ROI, RI and NPV for the three departments. Which department should be given the 1,650,000 to invest? (22 marks) ii. Economic Value Added (EVA) is another technique that Conan Engineering has considered. Discuss why EVA may not be regularly used by companies. (11% marks)
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