Question
The following 2 mutually exclusive projects (Project A and Project B) are available to Nandus Farm. They are producers of Sugar Cane. The initial cash
The following 2 mutually exclusive projects (Project A and Project B) are available to Nandus Farm. They are producers of Sugar Cane. The initial cash outlay and cash flows are shown below and Nandus will use straight line depreciation over each of the assets 4 year life and there will be no residual value on either investment.
Project A | Project B | |
Initial outlay | 235 000 | 80 000 |
Year/s | Cash Flows (A) | Cash Flows (B) |
1 | 27 000 | 38 000 |
2 | 37 000 | 38 000 |
3 | 99 000 | 28 000 |
4 | 200 000 | 7 000 |
NB: The Company requires a minimum accounting rate of return of 25% on all its investments
It rigidly applies a payback period of no more than 3.5 years.
Their after tax cost of capital is 12%.
Applicable tax rate is 30%.
2.1 Which project is more lucrative if the payback rule is applied? (5)
2.2 Apply the Accounting Rate of Return (ARR) test. Which project is more viable? (8)
2.3 Determine which project is more lucrative if the NPV rule is applied. (8)
2.4 Which of the above projects will you recommend to Nandus. Explain in detail your choice of answer (by critically assessing each of the above calculations that you have made) (4)
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