Question
In assessing the viability of capital projects, the division currently uses a target accounting rate of return of 20% (based on the average investment over
In assessing the viability of capital projects, the division currently uses a target accounting rate of return of 20% (based on the average investment over the period) and a target payback period of three years. It will undertake a project only if BOTH the accounting rate of return and the payback period meet or exceed the targets. The following data are available for this proposed investment.
Cost of refurbishment 30,000,000
Annual increased revenues 20,000,000
Annual increased staff costs (5,300,000)
Annual increased other costs* (4,200,000)
* No depreciation is included in these figures. After six years, it is thought that most of the fittings would have become outdated and would have a residual value of only R6 million.
The companys cost of capital is 10% per annum.
iii. Calculate the accounting rate of return and the payback period for the project and recommend on a purely financial basis whether the project should proceed.
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