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Projects Ltd intends to acquire a new machine costing 50,000 which is expected to have a life of fiv
from operation of the machine are expected to occur on the last day of each year as follows. End of
& show working out i) the Accounting Rate of Return (ARR), ii) the Payback Period (PP), iii) the Net
Internal Rate of Return (IRR)
Part (I) Accounting Rate of Return
Year Cash Flow
1
2
3
4
5
Depreciation
8000
8000
8000
8000
8000
10000
15000
20000
25000
25000
Total Profit
Average Profit(Per Year)= Total Profit/No. Of Periods
= 55000/5= 11000
Average Investment
= (beginning Investment + Ending Investment)/2
= (50000+10000)/2 = 30000
Accounting Rate of Return = (Average Profit/Average Investment)*100
Accounting Rate of Return = (11000/30000)*100=36.67%
Note: Its assumed the its a straight line Depreciation
Hence Depreciation per year would be = (Investment Value-Salvage Value)/Number of y
Depreciation= (50000-10000)/5 = 8000
Part (ii) Payback Period
Year
Cash Flow
0
1
2
Cumulative Cash Flow
-50000
-50000
10000
-40000
15000
-25000
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3
4
5
20000
25000
25000
-5000
20000
45000
Payback period is the length of the period in which initial
investment is recovered. So payback period is between year 3 &
4.
Payback period = 3+ 5000/25000 = 3.2 years
Part (iii) NPV
(NPV is the same of the present value of all future cashflows)
Year
Cash Flow
0
1
2
3
4
5
PV factor @ 10%
-50000
10000
15000
20000
25000
25000
1
0.9091
0.8264
0.7513
0.6830
0.6209
NPV (in Pounds)
Part (iv) IRR
IRR is the rate at which the present value of cash inflow would be equal to present value
Year
Cash Flow
0
1
2
3
4
5
IRR (Using Excel
Formula)
-50000
10000
15000
20000
25000
25000
21.86%
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(Incase we need to calculate Accounting rate of return per year. Solution given below
Year
1
2
3
4
5
Beg Investment
Ending Investment
50000
42000
42000
34000
34000
26000
26000
18000
18000
10000
IRR (Using Trial Method)
IRR is the rate at which the present value of cash inflow would be equal to present value
As calculated in in part 3 NPV is positive @10% so we would use a discount rate greater
Year
Cash Flow
0
1
2
3
4
5
PV factor @ 10%
-50000
10000
15000
20000
25000
25000
1
0.8333
0.6944
0.5787
0.4823
0.4019
NPV (in Pounds)
NPV is still Positive we would now use rate of 22%
Year
Cash Flow
0
1
2
3
4
5
PV factor @ 22%
-50000
10000
15000
20000
25000
25000
1
0.8197
0.6719
0.5507
0.4514
0.3700
NPV (in Pounds)
Now NPV is negative. Since at 20% NPV is positive and at 22% its negative we would us
Year
Cash Flow
0
1
PV factor @ 21.86%
-50000
10000
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1
0.8206
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2
3
4
5
15000
20000
25000
25000
0.6734
0.5526
0.4535
0.3721
NPV (in Pounds)
Since NPV is approximately zero at 21.86%. so IRR is 21.86%
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h is expected to have a life of five years, with a scrap value of 10,000 at the end of that time. Cash flows aris
of each year as follows. End of year 1 10,000 2 15,000 3 20,000 4 25,000 5 25,000 Required: Calcula
ayback Period (PP), iii) the Net Present Value (NPV; assume a discount rate of 10% per annum), and iv) the
Net Profit
(Cash Flow-Depreciation)
2000
7000
12000
17000
17000
55000
estment)*100
lue-Salvage Value)/Number of year. Hence
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Present Value
(Cash flow * PV factor)
-50000
9090.9090909091
12396.694214876
15026.2960180316
17075.3363841268
15523.0330764789
19112.2687844223
would be equal to present value of cash outflow (i.e. NPV would be zero)
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er year. Solution given below
Average Investment
Net Profit Accounting Rate of Return
46000
2000
4.35%
38000
7000
18.42%
30000
12000
40.00%
22000
17000
77.27%
14000
17000
121.43%
would be equal to present value of cash outflow (i.e. NPV would be zero)
ould use a discount rate greater than 10% to find out a rate at which NPV is zero. Let use 20% rate
Present Value
(Cash flow * PV factor)
-50000
8333.3333333333
10416.6666666667
11574.0740740741
12056.3271604938
10046.9393004115
2427.3405349794
Present Value
(Cash flow * PV factor)
-50000
8196.7213114754
10077.9360386993
11014.1377472123
11284.9772000126
9249.9813114858
-176.2463911146
t 22% its negative we would use some rate between these two rate. Let use 21.86%
Present Value
(Cash flow * PV factor)
-50000
8206.1381913672
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10101.1056023722
11052.1424611545
11336.9260433638
9303.2381777153
-0.45
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of that time. Cash flows arising
5 25,000 Required: Calculate
% per annum), and iv) the
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Let use 20% rate
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