Question
The directors of Fab Plc are considering two investment projects (X and Y). Both projects have estimated life of five years. Project X requires 2,000,000
The directors of Fab Plc are considering two investment projects (X and Y). Both projects have estimated life of five years. Project X requires 2,000,000 as an initial expenditure payable immediately and project Y costs also 2,000,000 half payable now and half payable after one year. Project Y requires an additional 130,000 as a working capital to support the investment.
At the end of five years, it is expected that the residual value of project X will be 130,000 and 200,000 for project Y.
The following is the best cash forecasts for net cash flows over the 5 years.
Year Project X Project Y
1 685,000 530,000
2 765,000 558,000
3 831,000 598,000
4 552,000 670,000
5 135,000 900,000
Required
a) Evaluate the two projects using the following two methods:
i) Payback period.
(4 marks)
ii) Net present value using 13% as a discount rate.
(7 marks)
Note: the discount rates table of present value attached above.
b) You need to comment on your answer in a) and recommend which project should be undertaken. The comments should include a discussion of the main advantages and disadvantages of the two methods and a conclusion stating the reasons for selecting one of the projects considering the two methods.
(8 marks)
c) In order to obtain a reliable result using any of the investment appraisal methods, you need to consider all relevant cash inflows & outflows relevant to the projects under consideration. Sunk costs, working capital and residual values are examples of such items.
You need to evaluate and discuss each of these three items in terms of their relevancy to the investment appraisal calculation and, briefly explain the rationale behind taking or not taking each into consideration during the computation of the two methods calculated above in a).
(6 marks)
Discount rate table:
4% Periods (n) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 2% 3% 0.980 0.971 0.961 0.943 0.942 0.915 0.924 0.888 0.906 0.863 0.888 0.837 0.871 0.813 0.853 0.789 0.837 0.766 0.820 0.744 0.804 0.722 0.788 0.701 0.773 0.681 0.758 0.661 0.743 0.642 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 Discount rates (r) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0.705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 7% 8% 0.935 0.926 0.873 0.857 0.816 0.794 0.763 0.735 0.713 0.681 0.666 0.630 0.623 0.583 0.582 0.540 0.544 0.500 0.508 0.463 0.475 0.429 0.444 0.397 0.415 0.368 0.388 0.340 0.362 0.315 9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 11% 19% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0.901 0.812 0.731 0.659 0.593 0.535 0.482 0.434 0.391 0.352 0.317 0.286 0.258 0.232 0.209 12% 13% 14% 0.893 0.885 0.877 0.797 0.783 0.769 0.712 0.693 0.675 0.636 0.613 0.592 0.567 0.543 0.519 0.507 0.480 0.456 0.452 0.425 0.400 0.404 0.376 0.351 0.361 0.333 0.308 0.322 0.295 0.270 0.287 0.261 0.237 0.257 0.231 0.208 0.229 0.204 0.182 0.205 0.181 0.160 0.183 0.160 0.140 15% 16% 17% 18% 0.870 0.862 0.855 0.847 0.756 0.743 0.731 0.718 0.658 0.641 0.624 0.609 0.572 0.552 0.534 0.516 0.497 0.476 0.456 0.437 0.432 0.410 0.390 0.370 0.376 0.354 0.333 0.314 0.327 0.305 0.285 0.266 0.284 0.263 0.243 0.225 0.247 0.227 0.208 0.191 0.215 0.195 0.178 0.162 0.187 0.168 0.152 0.137 0.163 0.145 0.130 0.116 0.141 0.125 0.111 0.099 0.123 0.108 0.095 0.084 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.074 20% 0.833 0.694 0.579 0.482 0.402 0.335 0.279 0.233 0.194 0.162 0.135 0.112 0.093 0.078 0.065 21% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 0.826 0.683 0.565 0.467 0.386 0.319 0.263 0.218 0.180 0.149 0.123 0.102 0.084 0.069 0.057 22% 23% 24% 25% 26% 27% 28% 29% 30% 0.820 0.813 0.807 0.800 0.794 0.787 0.781 0.775 0.769 0.672 0.661 0.650 0.640 0.630 0.620 0.610 0.601 0.592 0.551 0.537 0.525 0.512 0.500 0.488 0.477 0.466 0.455 0.451 0.437 0.423 0.410 0.397 0.384 0.373 0.361 0.350 0.370 0.355 0.341 0.328 0.315 0.303 0.291 0.280 0.269 0.303 0.289 0.275 0.262 0.250 0.238 0.227 0.217 0.207 0.249 0.235 0.222 0.210 0.198 0.188 0.178 0.168 0.159 0.204 0.191 0.179 0.168 0.157 0.148 0.139 0.130 0.123 0.167 0.155 0.144 0.134 0.125 0.116 0.108 0.101 0.094 0.137 0.126 0.116 0.107 0.099 0.092 0.085 0.078 0.073 0.112 0.103 0.094 0.086 0.079 0.072 0.066 0.061 0.056 0.092 0.083 0.076 0.069 0.063 0.057 0.052 0.047 0.043 0.075 0.068 0.061 0.055 0.050 0.045 0.040 0.037 0.033 0.062 0.055 0.049 0.044 0.039 0.035 0.032 0.028 0.025 0.051 0.045 0.040 0.035 0.031 0.028 0.025 0.022 0.020
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