FINANCIAL QUESTION TWO [25]

2.1. Evaluate the Internal Rate of Return as an investment appraisal technique. (show formula and answers)

2.2 RP Investments Ltd have just made an investment of R550 000 in new equipment.

Additional information:

Expected useful life 5 years (straight line depreciation)

Salvage value 50 000

Cost of Capital 10% after tax Tax rate 30% Years

Years Cash flows

1 220 000

2 200 000

3 120 000

4 110 000

5 50000

Required:

2.2.1 Calculate the payback period (4) and the accounting rate of return (4) ( taking ARR = Average Profits/Average Investment * 100)

2.2.2 RP Investments Ltd requires a payback period of no more than 3 years and an accounting rate of return of at least 30%. On the basis of these criteria, should this project be accepted? Justify your answer. (5)

2.2.3 The payback period method makes a crucial omission in its calculation, namely the time value of money. Complete the above computation using a method that accounts for the time value of money. On the basis of this calculation, should the project be accepted? Justify your answer.(show workings of discounted payback period)