Suave Ltd. is considering the selection of one of two mutually exclusive projects. Both would involve purchasing machinery with an estimated useful life of 5 years.

Project 1 would generate annual cash flows (receipts less payments) of 200,000; the machinery would cost 556,000 with a scrap value of 56,000.

Project 2 would generate cash flows of 500,000 per annum; the machinery would cost 1,616,000 with a scrap value of 301,000.

Suave uses straight-line depreciation. Its cost of capital is 15% per annum.

Assume that all cash flows arise on the anniversaries of the initial outlay, that there are no price changes over the project lives, and that accepting either project will have no impact on working capital requirements.

Assess the choice using the following methods by completing the calculations shown below:

• ARR
• NPV
• IRR
• Payback period

Calculate the missing answers:

	Project 1	Project 2
ARR(see workings)	33%	???
NPV (000)	???	210
IRR	25%	???
Payback Period (yrs)	???	3.2

ARR workings (Project 1)

Cash flows	200
Less: depreciation (see below)	100
Accounting profits	100

These profits are the same each year in this question.

Annual depreciation (Cost SV) / 5

(556,000 56,000) / 5

100

Average NBV of investments

(556 + 56) /2	306
ARR	33%

Be sure to demonstrate your workings.