Question 1 (50 marks)

May Corporation Holdings is considering two mutually exclusive projects. The company intends to invest in either one of the projects. May Corporation Holdings required rate of return is 10 percent. Initial outlay for the investment is $50,000. The annual average profit for projects XY and AB is $25,900 and $13,800 respectively.

The cash inflows after tax from both projects are as follows:

Year	Project XY	Project AB
1	10,500	10,650
2	20,650	12,400
3	20,000	15,000
4	25,200	33,600
5	10,000	1,000

REQUIRED:

(a) Determine for both projects, XY and AB the following: -

i) Average Accounting Return (AAR) (6 marks)

ii) Payback Period (6 marks)

iii) Net Present Value (NPV) (6 marks)

iv) Profitability Index (6 marks)

(b) Which project should May Corporation Holdings choose based on the Payback Period, NPV and PI methods and why? (6 marks)

(c) May Corporation Holdings has spent $400,000 on research to develop a new computer game. The firm is planning to spend $200,000 on a machine to produce the new game. Shipping and installation costs of the machine will be capitalized $50,000 and depreciated using the straight-line depreciation method. The machine has an expected life of three years, a $75,000 estimated resale value. Revenue from the new game is expected to be $600,000 per year, with costs of $250,000 per year.

The firm has a tax rate of 21 percent and it expects net working capital to increase by $100,000 at the beginning of the project. Prepare the cash flows for this project. (20 marks)