The finance manager of KK Smith & Sons plc is evaluating two mutually exclusive projects with the following cash flows.

Year

Project X ()

Project Y ()

0

(110,000)

(200,000)

1

45,000

50,000

2

45,000

50,000

3

30,000

50,000

4

30,000

100,000

5

20,000

55,000

The company's current return on capital employed is 12 per cent (average investment basis) and the company uses straight-line depreciation over the life of the project.

Required:

(1) Advise KK Smith & Sons which project should be undertaken using:

(i) the payback method of investment appraisal:13

(ii) the return on capital employed (ROCE) method of investment appraisal:

(iii) the net present value method of investment appraisal.

(2) Critically assess and discuss the problems that arise for the net present value method of investment appraisal when capital is limited, and explain how such problems may be resolved in practice.