Generic PLC is considering two mutually exclusive project proposals for new investment. The initial outlay of both projects involves buying machinery for 300,000, but will yield different levels of cash flows over the life of the project. The projects are estimated to last for five years. They will have no residual value at the end of their lives. Depreciation is charged on a straight line basis. The company uses an 8% discount rate for the cost of capital. The cash flows of both projects are as follows:

Year		Project A Cash flows	Project B Cash flows
1		80000	100000
2		80000	100000
3		80000	90000
4		100000	80000
5		100000	40000

Required:

1. Appraise each project using:
   1. The Payback method (not discounted)

8 marks

2. The Net Present Value method

8 marks

2. The project has a normal pattern of cash flows (i.e. an initial outflow followed by several years of inflows). What would be the effects of an increase in the companys cost of capital on the internal rate of return (IRR) of the chosen project. Would the IRR be higher or lower?

5 marks

3. Calculate the net present value of Project A if we take account of a corporate tax rate at 20 per cent and instead consider that investments in plant and machinery are eligible for 25 per cent annual writing-down allowances on the written-down value using the reducing balance method of depreciation. Tax is charged one year after the end of the companys accounting year. The machine is sold at its written down value in year 5.

Present Value Table discount rate 8% period 1 0926 2 0857 3 0794 4 0735 5 0681