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Calculate NPV, IRR And Payback Period For Two Projects

Question

Offshores Ltd is considering the selection of one of a pair of mutually exclusive investment projects. Both would involve purchase of machinery with a life of five years. Project 1 would generate annual cash flows (receipts less payments) of £400,000; the machinery would cost £1,112,000 and have a scrap value of £112,000. Project 2 would generate annual cash flows of £1000,000; the machinery would cost £3,232,000 and have a scrap value of £602,000. Offshores Ltds uses the straight-line method for providing depreciation and requires projects outflows to be recovered within three years. They require a project rate of return of 20%. Its cost of capital is 15 per cent per annum. Assume that annual cash flows arise on the anniversaries of the initial outlay, that there will be no price changes over the project lives and that acceptance of one of the projects will not alter the required amount of working capital.

Requirements

Calculate for each project:

  • The accounting rate of return (i.e. the percentage of the average accounting profit to the average book value of investment) to the nearest 1% and comment on your findings.         
  • The net present value and comment on your findings                                                    
  • The internal rate of return (Yield or Economic return) to the nearest 1%, and comment on your findings.
  • The payback period and comment on your findings

 

Summary

The question belongs to Finance and it discusses about calculating accounting rate of return, net present value, internal rate of return and payback period for two projects. Compare and analyze which is the better project to go with.

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