Question 2 Philip Photocopy (PP) operates printing services in shopping malls and universities It is considering expanding the business and have identified two possible sites Given PPs current circumstances, it can only afford expansion into one of the two sites Proposed Sites Cash Outflow Estimated Cash Inflow No of Year 0 Years 1 to 3 Years 4 to 5 Machines University shop $30,000 $40,000 10 City shop $70,000 $54,000 $54,000 20 The university shop is located in the library of a local university It is based on a three year contract The last operator only operated for three years and did not want to renew the contract due to poor demand The city shop is in a mall where there are many tuition and enrichment centres, and near two secondary schools The previous tenant of the city shop operated a gift shop only considers capital investments with a payback period of 3 years or less The company also assesses investments using accounting rate of return PP bases an investments accounting rate of return on the average investment in the project The minimum required rate of return set by PP is 12 Average annual expenses (including depreciation) are $20,000 for university shop and $32,000 for the city shop respectively All revenue will be received in cash in the same period expenses other than depreciation will be paid in cash in the same period Both projects have no residual value The depreciation method used is the same for both accounting and tax purposes The annual depreciation expense for each shop is $3,750 for the university shop and $8,000 for the city shop PPs effective tax rate is 15 , and taxes are paid in the same period incurred Required Compute the after tax net present value of each proposed shop (Note PV factors for 12 are as follows Year 1 0 89 Year 2 0 80 Year 3 0 71 Year 4 0 64 Year 5 0 57 the PV annuity factor for 12 , 3 years 2 40 and 5 years 3 61) (8 marks) Calculate the payback period for each proposed shop (2 marks) Compute the expected accounting rate of return (before taxes) for each proposed shop (4 marks) PP evaluates capital investment opportunities based on payback period and accounting rate of return Which proposed expansion option would PP select Explain (6 marks) Given your answers from part (a) to (d), critically evaluate the capital investment evaluation techniques used by PP to come to the decision in part (d) (7 marks)

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Question 2 Philip Photocopy (PP) operates printing services in shopping malls and universities. It is considering expanding the business and have identified two possible sites.

Question 2

Philip Photocopy (PP) operates printing services in shopping malls and universities. It is considering expanding the business and have identified two possible sites. Given PPs current circumstances, it can only afford expansion into one of the two sites.

Proposed Sites	Cash Outflow	Estimated Cash Inflow		No. of
Proposed Sites	Year 0	Years 1 to 3	Years 4 to 5	Machines
	Year 0	Years 1 to 3	Years 4 to 5	Machines

University shop	$30,000	$40,000	---------	10

City shop	$70,000	$54,000	$54,000	20

The university shop is located in the library of a local university. It is based on a three-year contract. The last operator only operated for three years and did not want to renew the contract due to poor demand. The city shop is in a mall where there are many tuition and enrichment centres, and near two secondary schools. The previous tenant of the city shop operated a gift shop.

only considers capital investments with a payback period of 3 years or less. The company also assesses investments using accounting rate of return. PP bases an investments accounting rate of return on the average investment in the project. The minimum required rate of return set by PP is 12%. Average annual expenses (including depreciation) are $20,000 for university shop and $32,000 for the city shop respectively. All revenue will be received in cash in the same period; expenses other than depreciation will be paid in cash in the same period. Both projects have no residual value. The depreciation method used is the same for both accounting and tax purposes. The annual depreciation expense for each shop is $3,750 for the university shop and $8,000 for the city shop. PPs effective tax rate is 15%, and taxes are paid in the same period incurred.

Required:

Compute the after tax net present value of each proposed shop.

(Note: PV factors for 12% are as follows: Year 1 = 0.89; Year 2 = 0.80; Year 3 = 0.71; Year 4 = 0.64; Year 5 = 0.57; the PV annuity factor for 12%, 3 years = 2.40 and 5 years = 3.61)

(8 marks)

Calculate the payback period for each proposed shop.

(2 marks)

Compute the expected accounting rate of return (before taxes) for each proposed shop.

(4 marks)

PP evaluates capital investment opportunities based on payback period and accounting rate of return. Which proposed expansion option would PP select? Explain.

(6 marks)

Given your answers from part (a) to (d), critically evaluate the capital investment evaluation techniques used by PP to come to the decision in part (d).

(7 marks)