The directors of Gear plc need to appraise two capital investment projects (X and Y) and decide which one they need to invest their money in. Both projects have estimated life of five years and require 2,000,000 as an initial expenditure however, 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:

The directors of Gear plc need to appraise two capital investment projects (X and Y) and decide which one they need to invest their money in. Both projects have estimated life of five years and require 2,000,000 as an initial expenditure however, 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

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

- Present value rate at 13%

Year 1 2 3 4 5

Rate 0.885 0.783 0.693 0.613 0.543

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)

b) You need to comment on your answer in 1 and recommend which project should be undertaken. The discussion should include a debate on the main advantages and disadvantages of 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 process and, briefly explain the rationale behind considering each in the computation of the two methods calculated above in the case of it is relevant item.

(Since Chugg limits it to only 4 units I needed an answer for part c )

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

- Present value rate at 13%

Year 1 2 3 4 5

Rate 0.885 0.783 0.693 0.613 0.543

Required

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 process and, briefly explain the rationale behind considering each in the computation of the two methods calculated above in the case of it is relevant item.