QUESTION THREE

The following information relates to three possible capital expenditure projects. However, because of capital rationing, only one project can be accepted.

PROJECT ONE:

Project ONE costs R420 000 and has an expected lifespan of 5 years. The cash flows for each year are R160 000, R140 000, R130 000, R120 000 and R110 000 for each of the respective years. The project will be sold at the end of the 5 years for R20 000.

PROJECT TWO:

Project TWO costs R550 000. The company will utilize this project for 5 years after which the asset will be sold for R30 000. The cash flows for years one and two are R200 000 and R140 000 respectively. The cash flow for the remaining three years is R100 000 in each year.

PROJECT THREE:

Project THREE has an initial investment of R430 000. The cash flows for the 4 years of the project are R110 000, R65 000, R95 000 and R100 000 respectively for each of the 4 years.

Additional Notes:

Cost of capital is 18%

3.1 Calculate the payback period for Project TWO. (Answer must be expressed in years and months) (4 marks)

3.2 Calculate the accounting rate of return for Project THREE. (Answer expressed to 2 decimal places) (6 marks

3.3 Calculate the net present value of each project. (Round off amounts to the nearest Rand) (12 marks)

3.4 Using the answers from question 3.3, which project should be chosen? Explain why. (3 marks)