Ch6_Making Inv Dec with NPV - Holden book Ch14
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Finance
Date
May 4, 2024
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Step 1
Step 2
Step 3
Total Sales
- Total Variable Costs
- Total Fixed Costs
- Depreciation [(Initial Investment - Salvage Value) / # years to fully depreciate]
____________________
= Operating Profit
- Taxes
____________________
Net Profit
+ Add Back Depreciation
_____________________
Operating Cash Flow
Find present values (PV) of all cash flows
PV = Cash Flows(t) / ( 1 + CDF(t) )
Cumulative Discount Factor
= CDF(t) = (1 + CDF(t-1) )*(1 + Nominal Cost of capital(t) ) - 1
keep CDF(0) = 0
1+Real Cost of capital = (1+Nominal cost of capital)/(1+Inflation Rate)
Nominal cost of capital = (1+Real Cost of capital)* (1+Inflation Rate) - 1
Find NPV
Net Present Value = PV of all cash flows - Initial Investment
Basics
(in thousands of $)
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Year 7
Key Assumptions
Unit Sales
3000
4000
5600
6800
7400
3700
3000
Inflation Rate
2.0%
2.5%
3.0%
3.5%
4.0%
4.0%
4.0%
Real Cost of Capital
11.0%
11.2%
11.4%
11.6%
11.8%
12.0%
12.2%
Tax Rate
21.0%
21.0%
21.0%
21.0%
21.0%
21.0%
21.0%
Discounting
Discount Rate = Nominal Cost of Capital
Cumulative Discount Factor
0.0%
Price or Cost / Unit
Sales Revenue / Unit
$9.70 Variable Cost / Unit
$7.40 Cash Fixed Costs
$5,280 Cash Flow Forecasts
Sales Revenue
Variable Costs
Gross Margin
Cash Fixed Costs
Depreciation
Total Fixed Costs
Operating Profit
Taxes
Net Profit
Add Back Depreciation
Operating Cash Flow
Investment in Plant & Equip
($11,350)
$1,400 Cash Flows
Present Value of Each Cash Flow
Net Present Value
P
ROJECT NPV
Sensitivity Analysis
(in thousands of $)
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Key Assumptions
Base Case Unit Sales
3000
4000
5600
6800
7400
Unit Sales Scale Factor
100.0%
Unit Sales
Inflation Rate
2.0%
2.5%
3.0%
3.5%
4.0%
Real Cost of Capital Increment
0.2%
0.4%
0.6%
0.8%
Real Cost of Capital
11.0%
Tax Rate
21.0%
21.0%
21.0%
21.0%
21.0%
Discounting
Discount Rate = Nominal Cost of Capital
13.2%
2.5%
3.0%
3.5%
4.0%
Cumulative Discount Factor
0.0%
13.2%
16.1%
19.5%
23.7%
28.7%
Price or Cost / Unit
Sales Revenue / Unit
$9.70 $9.94 $10.24 $10.60 $11.02 Variable Costs / Unit:
Direct Labor
$3.50 $3.59 $3.70 $3.82 $3.98 Materials
$2.00 $2.05 $2.11 $2.19 $2.27 Selling Expenses
$1.20 $1.23 $1.27 $1.31 $1.36 Other
$0.70 $0.72 $0.74 $0.76 $0.80 Total Variable Cost / Unit
$7.40 $7.59 $7.81 $8.09 $8.41 Cash Fixed Costs:
Lease Payment
$2,800 $2,870 $2,956 $3,060 $3,182 Property Taxes
$580 $595 $612 $634 $659 Administration
$450 $461 $475 $492 $511 Advertising
$930 $953 $982 $1,016 $1,057 Other
$520 $533 $549 $568 $591 Total Cash Fixed Costs
$5,280 $5,412 $5,574 $5,769 $6,000 Working Capital
Work Cap / Next Yr Unit Sales
$0.87 Working Capital
P
ROJECT NPV
Cash Flow Forecasts
Sales Revenue
$0 $0 $0 $0 $0 Variable Costs
$0 $0 $0 $0 $0 Gross Margin
$0 $0 $0 $0 $0 Cash Fixed Costs
$5,280 $5,412 $5,574 $5,769 $6,000 Depreciation
$1,421 $1,421 $1,421 $1,421 $1,421 Total Fixed Costs
$6,701 $6,833 $6,996 $7,191 $7,422 Operating Profit
($6,701)
($6,833)
($6,996)
($7,191)
($7,422)
Taxes
($1,407)
($1,435)
($1,469)
($1,510)
($1,559)
Net Profit
($5,294)
($5,398)
($5,527)
($5,681)
($5,863)
Add Back Depreciation
$1,421 $1,421 $1,421 $1,421 $1,421 Operating Cash Flow
($3,873)
($3,977)
($4,105)
($4,259)
($4,442)
Investment in Working Capital
Investment in Plant & Equip
($11,350)
Investment Cash Flow
($11,350)
$0 $0 $0 $0 $0 Cash Flows
($11,350)
($3,873)
($3,977)
($4,105)
($4,259)
($4,442)
Present Value of Each Cash Flow
($11,350)
($3,421)
($3,427)
($3,434)
($3,443)
($3,452)
Net Present Value
($34,452)
Data Table: Sensitivity of the Net Present Value to Unit Sales and Date 0 Real Cost of Capital
Input Values for Unit Sales Scale Factor
Out Formula: Net Present Value
80%
90%
100%
110%
120%
9.0%
Input Values for
11.0%
Date 0 Real Cost of Capital
13.0%
15.0%
17.0%
Sensitivity of Project NPV to Unit Sales and Cost of Capital
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Related Questions
F Question Viewer
Cost of Goods Sold
- Depreciation
= EBIT
- Taxes (20%).
= Unlevered net income
+ Depreciation
- Additions to Net Working Capital
- Capital Expenditures
= Free Cash Flow
Year 0
A. 17%
B. 30%
C. 25%
D. 22%
_-400000_
Year 1
424897.541
- 165000
- 85000
174897.541
- 34979.508
139918.033
85000
- 20000
Year 2
424897.541
- 165000
- 85000
174897.541
- 34979.508
139918.033
85000
- 20000
Year 3
424897.541
- 165000
- 85000
174897.541
- 34979.508
139918.033
85000
- 20000
204918.033
204918.033
204918.033
Visby Rides, a livery car company, is considering buying some new luxury cars. After extensive research, they come up with the above estimates of free cash flow from this project. By how much could the
discount rate rise before the net present value (NPV) of this project is zero, given that it is currently 8%?
arrow_forward
Saved
Required information
[The following information applies to the questions displayed below.]
Peng Company is considering an investment expected to generate an average net income after taxes of $2,900 for three
years. The investment costs $47,100 and has an estimated $6,600 salvage value.
Compute the accounting rate of return for this investment; assume the company uses straight-line depreciation.
Accounting Rate of Return
Choose Numerator:
Choose Denominator:
Accounting Rate of Return
Accounting rate
return
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Calculate the conventional benefit-cost ratio for the alternative:
Initial Investment
Revenues
Costs
Salvage Value
Useful life
MARR
Select one:
a.1.3130
b.1.2960
c.1.4659
d.1.2114
e.1.3681
400000
190000
60000
100000
6
0.1
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>Unit-of-production method
This method amortizes the costs of oil and gas industry activities and
is dependent on the accounting method chosen by the owner of the
assets. The following general formula shows the concept of unit-of-
production amortization:
[unamortized costs at end of period]+|production for period
[Amortization for period]=!
reserves at the beginning of period
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11. Match each concept in Column A with a definition
or example in Column B.
Column A
Column B
1. Valuing time at the
a. Depreciation of
natural capital
wage that someone gives
up
2. Comparison with GDP
supports the diminishing
marginal utility of
b. Satellite accounts
income
c. An indicator of well-
3. Costs of cleaning up a
being including 11
toxic waste site
dimensions
d. An example of non
market production
4. The value of fish killed
by toxic waste
e. Opportunity-cost
method
5. Government
production
6. The effect on copper
f. Subjective well-being
reserves of copper mining
g. Maintenance costs
7. Better Life Index
8. The service performed
by a garbage dump
h. Defensive
expenditures
i. A way of measuring
well-being (not
production) using dollar
9. Cleanup costs
following an oil spill
amounts
10. Monetary or physical
j. Damage costs
measures that can be
related to GDP
11. Genuine Progress
k. Sink function
Indicator
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Use AstroTurf Company's income statement below to answer the following questions.
Operating costs (excl. depreciations & amortization): $4.5mDepreciation and amortization: $1.5mInterest: $0.7mNet Income: $2.8mTax Rate: 35%1. Calculate AstroTurf’s EBITDA.
Input your final answer here :
Explanation: Provide a step-by-step explanation for how you arrived at your above solution as though you were teaching a student to solve this type of problem. Provide a clear explanation, showing any steps or processes used to reach the answer.
What level of sales would generate a net income of $4.2m for the following year, knowing that operating costs (excl. depreciation and amortization) will increase by 7.5%, and given a 35% tax rate.
Explanation: Provide a step-by-step explanation for how you arrived at your solution as though you were teaching a student to solve this type of problem.
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LO 2
4. Calculating OCF Consider the following income statement:
Sales
$537,200
Costs
346,800
Depreciation
94,500
EBIT
?
Taxes (21%)
?
Net income
Fill in the missing numbers and then caicrlate e F What is the depreci-
ation tax shield?
5. Calculating Depreciation A piece of new p
equipment
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Question 1
Grey Ltd has provided the following figures for two investment projects, only one of which may
be chosen.
Project X
Project Y
£ _
Initial outlay
200,000
180,000
Profit for year 1
65,000
35,000
2
65,000
35,000
3
75,000
65,000
4
35,000
85,000
Estimated resale value at end of year 4
60,000
40,000
Profit is calculated after deducting straight line depreciation. The business has a cost of capital of
10%.
Required
a) Calculate for each project
i.
Payback
Average Return on Capital Employed
Net present value (NPV)
ii.
iii.
b) Critically discuss the merits and limitations of payback and NPV
(Your answer is to be presented in an essay format NOT Bullet Points)
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C1
C2
R
to
22800
18000
22100
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MACHINE A
MACHINE B
INITIAL COST
R100 000
R110 000
EXPECTED ECONOMIC LIFE
5 YEARS
5 YEARS
EXPECTED DISPOSAL/RESIDUAL VALUE
R10 000
EXPECTED NET CASH INFLOWS
R
R
END OF: YEAR 1
34 000
33 000
YEAR 2
27 000
33 000
YEAR 3
32 000
33 000
YEAR 4
30 000
33 000
YEAR 5
26 000
33 000
DEPRECIATION PER YEAR
18 000
22 000
COMPANY ESTIMATES COST CAPITAL = 14%
2) Calculate the accounting rate of return (on average investment) for Machine A. (answer rounded offto 2 decimal places).
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Required information
[The following information applies to the questions displayed below.]
Peng Company is considering an investment expected to generate an average net income after taxes of $1,950 for three
years. The investment costs $45,000 and has an estimated $6,000 salvage value.
Compute the accounting rate of return for this investment; assume the company uses straight-line depreciation.
Choose Numerator:
1
1
Accounting Rate of Return
Choose Denominator:
G
O
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QUESTION 3
If the first cost of an asset is $15,000, and an annual operating cost of $5000 with a salvage value of $3000 after 5 years. What will be
the Annual worth and the Capital recovery. If i- 10%
O AW -S-8465 and CR - $+4508
O AW = S-8465 and CR = $-4508
AW = S+4508 and CR = $-8465
O AW S-4508 and CR S-8465
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Question 7
A company can invest in two alternatives: Machine Eco and Machine Top.
The controlling department provides the following data.
Eco
total annual costs
annual sales
3.600.000,00 €
4.000.000,00 €
3.000.000,00 €
€
8
purchasing price machine
residual value
useful life (years)
The cost of capital are 10%.
How would you decide using the
• profit comparison calculation and
the profitability comparison?
When will the machines be amortized?
Question 8
Top
3.700.000,00 €
4.200.000,00 €
4.500.000,00 €
€
8
Please refer to question no. 7. What would be the results Eco had a residual value of € 500.000,-- and
Top of € 600.000,--?
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B2B Co. is considering the purchase of equipment that would allow the company to add a new product to its line. The equipment is
expected to cost $369,600 with a 8-year life and no salvage value. It will be depreciated on a straight-line basis. The company expects
to sell 147,840 units of the equipment's product each year. The expected annual income related to this equipment follows.
Sales
Costs
Materials, labor, and overhead (except depreciation on new equipment)
Depreciation on new equipment
Selling and administrative expenses
Total costs and expenses
Pretax income
Income taxes (30%)
Net income
Chart Values are Based on:
If at least an 10% return on this investment must be earned, compute the net present value of this investment. (PV of $1, FV of $1, PVA
of $1, and FVA of $1) (Use appropriate factor(s) from the tables provided.)
Select Chart
n=
j=
Amount
%
X PV Factor =
$
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MACHINE A
MACHINE B
INITIAL COST
R100 000
R110 000
EXPECTED ECONOMIC LIFE
5 YEARS
5 YEARS
EXPECTED DISPOSAL/RESIDUAL VALUE
R10 000
EXPECTED NET CASH INFLOWS
R
R
END OF: YEAR 1
34 000
33 000
YEAR 2
27 000
33 000
YEAR 3
32 000
33 000
YEAR 4
30 000
33 000
YEAR 5
26 000
33 000
DEPRECIATION PER YEAR
18 000
22 000
COMPANY ESTIMATES COST CAPITAL = 14%
4)Calculate the internal rate of return for Machine B.
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6. Determine the maximum operating income possible with the expanded plant.$fill in the blank 8
7. If the proposal is accepted and sales remain at the current level, what will the operating income or loss be for the following year?$fill in the blank 9
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Data
Using Incremental with EUAW analysis find the best alternative, MARR = %10.
You should use Excel and show your equations separately, see below example:
[A Benefit - [IC (A/P, i%, n) - Salvage (A/F, i, n)] + A Cost+ G Cost (A/G, i, n)]
First Cost
Salvage Value
Annual Benefit
M&O
M&O Gradient
Useful Life, Years
A
$2,300,000
$85,000
$580,000
$65,000
$10,000
10
B
$2,750,000
$125,000
$670,000
$78,000
$15,000
10
с
$2,550,000
$95,000
$650,000
$72,000
$12,500
10
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10.A business segment that has responsibility for both revenues and expenses is called__________________
11. Suppose an office building is owned for which long-term leases have been signed, the tenants pay utilities and operating costs, and straight-line depreciation is taken. The rate of return on the book value of this investment can be expected to _____________________
12. An advantage of centralization is ______________________
13. ROI will decrease if ____________________
14. Operating income is __________________
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SUBJECT: ENGINEERING ECONOMYTOPIC: DEPRECIATION
SHOW THE COMPLETE AND DETAILED SOLUTION OF THIS PROBLEM. THANK YOU EXPERTS.
E) Determine the rate of depreciation, the total depreciation up to the end of the 8th year and the book value at the end of 8 years for an asset that costs P150,000 when new and has an estimated scrap value of P20,000 at the end of 10 years using the double declining balance method.
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It is due today. Please help!
Can you help me find/solve the following?
1. PRIME COST (F+B+LABOR)
2. TOTAL COSTS OF SALES
3. TOTAL GROSS PROFIT
4. TOTAL INCOME
5. TOTAL INCOME LESS CONTROLLABLE
6. TOTAL OCCUPANCY COSTS
7. INCOME BEFORE INT, DEPR & TAX
8. TOTAL INTEREST EXPENSES
9. TOTAL DEPRECIATION EXPENSES
10. NET PROFIT or (LOSS)
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Year (n)
0
1
2
3
4
5
6
Costs ($) Savings ($) Net Cash Flow ($)
13,000
2,300
2.300
2,300
2,300
2.300
2,300
Find the rate of return for this project.
6,000
7,000
9,000
9,000
9,000
9,000
-13,000
3,700
4,700
6,700
6,700
6,700
6,700
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Hungry Whale Electronics is considering an investment that will have the following sales, variable costs, and fixed operating costs:
Sales (units)
Sales price
Variable cost per unit
Fixed costs, excluding depreciation
Accelerated depreciation rate
Year 1
Year 2
4,200
4,100
$29.82 $30.00
$12.15 $13.45
$41,000
33%
Year 3
4,300
$30.31
$14.02
$41,670 $41,890
45%
15%
This project will require an investment of $10,000 in new equipment. The equipment will have no salvage value at the end of the project's four-year
life. Hungry Whale Electronics pays a constant tax rate of 40%, and it has a required rate of return of 11%.
When using accelerated depreciation, the project's net present value (NPV) is
Using the
When using straight-line depreciation, the project's NPV is
Year 4
4,400
$33.19
$14.55
$40,100
7%
depreciation method will result in the greater NPV for the project.
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ems i
Your firm is considering purchasing a machine with the following annual, end-of-year,
book investment accounts.
Gross investment
Less: Accumulated
depreciation
Net investment
Year 0
Year 1
Year 2
Year 3
Year 4
$ 65,000 $ 65,000 $65.000 $ 65,000 $65,000
0
16,250 32,500 48,750 65,000
AAR
$ 65,000 $48.750 $ 32.500 $ 16,250 $
0
The machine generates, on average. $4.900 per year in additional net income. What is
the average accounting return for this machine? (Do not round intermediate
calculations and enter your answer as a percent rounded to 2 decimal places, e.g..
32.16.)
Saved
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Return on Investment; Present Value Depreciation; Spreadsheet Application As indicatedin the chapter, there are goal congruence problems associated with the use of ROI as an indicator ofbusiness unit financial performance. One such problem relates to the bias against accepting new investments because of the adverse effect on a business unit’s ROI metric. Assume, for example, that themanager of a business unit can invest in a new, depreciable asset costing $75,000 and that this asset hasa 3-year life with no salvage value. Cash inflows associated with this investment are projected to beas follows: $30,000, $35,000, and $43,200. (Ignore taxes.) This scenario leads to an estimated internalrate of return (IRR) of 19.44%. Assume that the minimum required rate of return is 15%.Required1. Demonstrate, using the IRR function in Excel, that the IRR on this proposed investment is indeed19.44%.2. Calculate the year-by-year return on investment (ROI) on this proposed investment. For this…
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Related Questions
- F Question Viewer Cost of Goods Sold - Depreciation = EBIT - Taxes (20%). = Unlevered net income + Depreciation - Additions to Net Working Capital - Capital Expenditures = Free Cash Flow Year 0 A. 17% B. 30% C. 25% D. 22% _-400000_ Year 1 424897.541 - 165000 - 85000 174897.541 - 34979.508 139918.033 85000 - 20000 Year 2 424897.541 - 165000 - 85000 174897.541 - 34979.508 139918.033 85000 - 20000 Year 3 424897.541 - 165000 - 85000 174897.541 - 34979.508 139918.033 85000 - 20000 204918.033 204918.033 204918.033 Visby Rides, a livery car company, is considering buying some new luxury cars. After extensive research, they come up with the above estimates of free cash flow from this project. By how much could the discount rate rise before the net present value (NPV) of this project is zero, given that it is currently 8%?arrow_forwardSaved Required information [The following information applies to the questions displayed below.] Peng Company is considering an investment expected to generate an average net income after taxes of $2,900 for three years. The investment costs $47,100 and has an estimated $6,600 salvage value. Compute the accounting rate of return for this investment; assume the company uses straight-line depreciation. Accounting Rate of Return Choose Numerator: Choose Denominator: Accounting Rate of Return Accounting rate returnarrow_forwardCalculate the conventional benefit-cost ratio for the alternative: Initial Investment Revenues Costs Salvage Value Useful life MARR Select one: a.1.3130 b.1.2960 c.1.4659 d.1.2114 e.1.3681 400000 190000 60000 100000 6 0.1arrow_forward
- >Unit-of-production method This method amortizes the costs of oil and gas industry activities and is dependent on the accounting method chosen by the owner of the assets. The following general formula shows the concept of unit-of- production amortization: [unamortized costs at end of period]+|production for period [Amortization for period]=! reserves at the beginning of periodarrow_forward11. Match each concept in Column A with a definition or example in Column B. Column A Column B 1. Valuing time at the a. Depreciation of natural capital wage that someone gives up 2. Comparison with GDP supports the diminishing marginal utility of b. Satellite accounts income c. An indicator of well- 3. Costs of cleaning up a being including 11 toxic waste site dimensions d. An example of non market production 4. The value of fish killed by toxic waste e. Opportunity-cost method 5. Government production 6. The effect on copper f. Subjective well-being reserves of copper mining g. Maintenance costs 7. Better Life Index 8. The service performed by a garbage dump h. Defensive expenditures i. A way of measuring well-being (not production) using dollar 9. Cleanup costs following an oil spill amounts 10. Monetary or physical j. Damage costs measures that can be related to GDP 11. Genuine Progress k. Sink function Indicatorarrow_forwardUse AstroTurf Company's income statement below to answer the following questions. Operating costs (excl. depreciations & amortization): $4.5mDepreciation and amortization: $1.5mInterest: $0.7mNet Income: $2.8mTax Rate: 35%1. Calculate AstroTurf’s EBITDA. Input your final answer here : Explanation: Provide a step-by-step explanation for how you arrived at your above solution as though you were teaching a student to solve this type of problem. Provide a clear explanation, showing any steps or processes used to reach the answer. What level of sales would generate a net income of $4.2m for the following year, knowing that operating costs (excl. depreciation and amortization) will increase by 7.5%, and given a 35% tax rate. Explanation: Provide a step-by-step explanation for how you arrived at your solution as though you were teaching a student to solve this type of problem.arrow_forward
- LO 2 4. Calculating OCF Consider the following income statement: Sales $537,200 Costs 346,800 Depreciation 94,500 EBIT ? Taxes (21%) ? Net income Fill in the missing numbers and then caicrlate e F What is the depreci- ation tax shield? 5. Calculating Depreciation A piece of new p equipmentarrow_forwardQuestion 1 Grey Ltd has provided the following figures for two investment projects, only one of which may be chosen. Project X Project Y £ _ Initial outlay 200,000 180,000 Profit for year 1 65,000 35,000 2 65,000 35,000 3 75,000 65,000 4 35,000 85,000 Estimated resale value at end of year 4 60,000 40,000 Profit is calculated after deducting straight line depreciation. The business has a cost of capital of 10%. Required a) Calculate for each project i. Payback Average Return on Capital Employed Net present value (NPV) ii. iii. b) Critically discuss the merits and limitations of payback and NPV (Your answer is to be presented in an essay format NOT Bullet Points)arrow_forwardC1 C2 R to 22800 18000 22100arrow_forward
- MACHINE A MACHINE B INITIAL COST R100 000 R110 000 EXPECTED ECONOMIC LIFE 5 YEARS 5 YEARS EXPECTED DISPOSAL/RESIDUAL VALUE R10 000 EXPECTED NET CASH INFLOWS R R END OF: YEAR 1 34 000 33 000 YEAR 2 27 000 33 000 YEAR 3 32 000 33 000 YEAR 4 30 000 33 000 YEAR 5 26 000 33 000 DEPRECIATION PER YEAR 18 000 22 000 COMPANY ESTIMATES COST CAPITAL = 14% 2) Calculate the accounting rate of return (on average investment) for Machine A. (answer rounded offto 2 decimal places).arrow_forwardRequired information [The following information applies to the questions displayed below.] Peng Company is considering an investment expected to generate an average net income after taxes of $1,950 for three years. The investment costs $45,000 and has an estimated $6,000 salvage value. Compute the accounting rate of return for this investment; assume the company uses straight-line depreciation. Choose Numerator: 1 1 Accounting Rate of Return Choose Denominator: G Oarrow_forwardQUESTION 3 If the first cost of an asset is $15,000, and an annual operating cost of $5000 with a salvage value of $3000 after 5 years. What will be the Annual worth and the Capital recovery. If i- 10% O AW -S-8465 and CR - $+4508 O AW = S-8465 and CR = $-4508 AW = S+4508 and CR = $-8465 O AW S-4508 and CR S-8465arrow_forward
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