Key Concept Exercise Part AFor the following exercise, complete the calculations below. Evaluate different capital investment appraisal techniques by completing the calculations shown below:Bongo Ltd. is considering the selection of one of two mutually exclusive projects. Both would involve purchasing machinery with an estimated useful life of 5 years.Project 1 would generate annual cash flows (receipts less payments) of £200,000; the machinery would cost £556,000 with a scrap value of £56,000.Project 2 would generate cash flows of £500,000 per annum; the machinery would cost £1,616,000 with a scrap value of £301,000.Bongo uses straight-line depreciation. Its cost of capital is 15% per annum.Assume that all cash flows arise on the anniversaries of the initial outlay, that there are no price changes over the project lives, and that accepting either project will have no impact on working capital requirements.Assess the choice using the following methods by completing the calculations shown below:• ARR• NPV• IRR• Payback periodCalculate the missing answers: Project 1 Project 2ARR (see workings) 33% ???NPV (£’000) ??? 210IRR 25% ???Payback Period (yrs) ??? 3.2ARR workings (Project 1)Cash flows 200Less: depreciation (see below) 100Accounting profits 100These profits are the same each year in this question.Annual depreciation (Cost – SV) / 5(556,000 – 56,000) / 5 100Average NBV of investments(556 + 56) /2 306ARR 33%Be sure to demonstrate your workings.
Key Concept Exercise Part BIn formulating your Key Concept Exercise, consider the following question:• What are some of the alternative methods of investment appraisal?In an approximately 500-word response, address the following issues/questions:Many businesses around the world still fail because their capital investment decisions are based upon a calculation on the back of an envelope and do not take any of the correct factors into account. Even larger businesses often get this wrong. This is a true sign of poor resource management.• Do you agree or disagree?• Discuss the alternative methods of investment appraisal and describe the limitations of these to help justify your arguments.• How do you think that capital budgeting decisions should ideally be made by different types of organisations?
Key Concept Exercise Part A
Date Published: 11 January, 2018