QUESTION 5 (20 Marks)

Note: Where applicable, use the present value tables provided in APPENDICES 1 and 2 that appear after the formula sheet.

REQUIRED Use the information provided below to answer the following questions: 5.1 Calculate the Payback Period of the first alternative (expressed in years, months and days). (3 marks)

5.2 Calculate the Accounting Rate of Return on initial investment of the first alternative (expressed to two decimal places). (4 marks)

5.3 Based on the Net Present Value, which alternative should be chosen? Why? (Show the calculations of the present values as well as the net present values.) (8 marks)

5.4 Calculate the Internal Rate of Return (expressed to two decimal places) of the first alternative. Your answer must include two net present value calculations (using consecutive rates/percentages) and interpolation. (5 marks)

INFORMATION The management of Torga Limited is considering two investment opportunities:

The first alternative involves the purchase of new machinery for R1 200 000 which will enable the company to modernise its production facility. The machinery is expected to have a useful life of five years and no salvage value is anticipated. On the day Torga Limited purchases the new machinery, it would also pay the supplier R60 000 for installation costs. The modernisation is expected to increase efficiency, resulting in a reduction in annual cash operating expenses of R380 000.

The second alternative involves purchasing a truck. The truck costs R1 200 000. Its useful life is expected to be five years and a salvage value of R300 000 is anticipated. Operating the truck will necessitate an increase of R60 000 in the companys working capital base immediately upon buying the truck. The working capital cash outflow is expected to be recovered at the end of the trucks useful life. The truck is expected to generate R730 000 per year in additional cash revenues. The drivers salary and other cash operating expenses are expected to be R360 000 per year. Torga Limited desires a rate of return of 12%. The straight-line method of depreciation is used. Ignore taxes.