QUESTION 3 (20 Marks)

Thungela Limited intends acquiring new plant and equipment and has provided the following information: Option 1 The plant and equipment can be acquired at a cost of R1 600 000. This equipment will have a five-year useful life and will be depreciated on a straight-line basis to its scrap value of R60 000. The new equipment will result in increases in net cash inflows as follows:

Year Net cash inflows

Year 1 - 350 000

Year 2 - 370 000

Year 3 - 410 000

Year 4 - 440 000

Year 5 - 480 000

Option 2

Plant and equipment can be imported at a cost of R1 200 000 and a further R120 000 will have to be incurred on transport and installation costs. The plant and equipment will have a useful life of four years and will generate net profits of R75 000 per year. The plant and equipment will be depreciated on a straight-line basis over its useful life and will be written down to its scrap value of R100 000 Other information: The company has a cost of capital of 9%.

REQUIRED: Note: when discounting cash flows use the discount factors as found in table 1 and table 2 of your module guide 3.1 Calculate the payback period for option 1 and 2 (The answer must be reflected in years and months) (4 Marks)

3.2 Calculate the net present value for option 1 and 2 (6 Marks)

3.3 Calculate the accounting rate of return on average investment for option 1 (Answer to be rounded to 2 decimal places) (5 Marks)

3.4 Calculate the internal rate of return for option 2 using the interpolation method assuming that there is no scrap value. (Answer to be rounded to 2 decimal places) (Use interpolation method with two consecutive percentages to calculate the internal rate of return) (3 Marks)

3.5 Based on the net present values calculated in 3.2 above, which option should be chosen and why? (2 Marks)