QUESTION THREE [20]

3.1 Explain the rationale behind the internal rate of return. (IRR) (3)

3.2 Super Max Investments have just made an investment of R550 000 in a new Tata Telcoline delivery vehicle. This vehicle will be used for deliveries and generate revenues from such activities.

Further details:

Expected useful life 5 years (straight line depreciation)

Salvage value 50 000

Cost of Capital 10% after tax

Tax rate 30%

Year Cash flows

1 -220 000

2 -200 000

3 -120 000

4 -110 000

5 -50 000

Required:

3 3.2.1 Calculate the payback period and the accounting rate of return. (8)

3.2.2 Super Max Investments requires a payback period of no more than 3 years and a return of at least 30%. Purely on the basis of these criteria, should this project be accepted? Explain your answer (2)

3.2.3 The payback period method makes a crucial omission in the calculation, namely the time value of money. Can you complete the above computation using a method that accounts for the time value of money? On the basis of this calculation, should the project be accepted? Explain your answer.