QUESTION TWO $[30]$

The following $2$ mutually exclusive projects $($Project A and Project B$)$ are available to Simonsbosch Farm. They are producers of Rooi Bos tea. The initial cash outlay and cash flows are shown below and Simonsbosch will use straight line depreciation over each of the assets $4$ year life and there will be no residual value on either investment.

Years

Cash Flows $($A$)$

Cash Flows $($B$)$

$0($Investment$)$

$-240000$

$-90000$

$1$

$28000$

$40000$

$2$

$38000$

$40000$

$3$

$100000$

$30000$

$4$

$200000$

$7000$

Additional information:

a$.$

The company requires a minimum accounting rate of return of $25\%$ on all its investments.

b$.$

It rigidly applies a payback period of no more than $3\mathrm{.}5$ years.

c$.$

Their after tax cost of capital is $12\%.$

d$.$

Applicable tax rate is $30\%.$

Required:

$2\mathrm{.}1.$ Which project is more lucrative if the payback rule is applied? $(5)$

$2\mathrm{.}2.$ Apply the Accounting Rate of Return $($ARR$)$ test. Which project is more viable? $(8)$

$2\mathrm{.}3.$ Determine which project is more lucrative if the NPV rule is applied. $(8)$

$2\mathrm{.}4.$ Which of the above projects will you recommend to Simonsbosch. Explain in details

your choice of answer $($by critically assessing each of the above calculations that

you have made$)(4)$