Question 3

Taomi Ltd, a competitor of Kievon Ltd, also intends to venture into the hair straightening dryer market. They have estimated the initial investment to be similar to Kievon's $4 million, and installation cost would be an additional $150 000.

Taomi has estimated the annual net profits (after tax) as follows:

Year (t) 1 2 3 4 5

Net Profit 900 000 1 800 000 2 000 00 2 000 000 1 500 000

(a) Calculate the Accounting Rate of Return for this project.

(b) Discuss one advantage the ARR method has over the other investment appraisal methods from a shareholder's point of view. (With academic journals citation).

(c ) Besides the estimated net profits, the following transactions would be associated with the proposed project.

(i) The new production line would require the repossession of an entire floor of its production plant. This level of the plant is currently leased to a textile recycling sorter, whose rent will expire in 2 months. The lease is likely to be renewed.

(ii) Part of an existing conveyor system in-place on the production level could be integrated into the new production line. This conveyor system was installed 5 years ago for $500 000.

(iii) It is predicted that this hair straightening dryer would increase annual sales of an existing product line, heat protectant spray.

(iv) Taomi would need to appoint a Product Director for this new product range, and this portfolio would be assigned to the current Product Director of air purifier.

(v) The initial investment of $4 million required could have been invested in a mutual fund with similar projected return from this project.

Required:

Identify and briefly explain whether each of the above transactions would be treated as a incremental cash flow, sunk cost or an opportunity cost, in developing the relevant cash flows associated with the proposed sensor installation decision.