Average annual accounting profit = 999,675/4 = $249,919 Average investment = 2,000,000/2 = $1,000,000 Return on capital employed = 100 x 249,919/1,000,000 = 25% (iv) Calculation of discounted payback Year 0 1 2 3 4 $ $$$ $ PV of cash flows (2,000,000) 509,040) 574,919) 1,014,430 268,333 Cumulative PV (2,000,000) (1,490,960) (916,041) 98,389 366,722 Discounted payback period = 2 + (916,041/1,014,430) = 2 + 0·9 = 2·9 years (c) Discuss your findings in each section of (b) above and advise whether the investment proposal is financially acceptable. The investment proposal has a positive net present value (NPV) of $366,722 and is therefore financially acceptable. The results of the other investment appraisal methods do not alter this financial acceptability, as the NPV decision rule will always offer the correct investment advice. The internal rate of return (IRR) method also recommends accepting the investment proposal, since the IRR of 18·2% is greater than the 10% return required by PV Co. If the advice offered by the IRR method differed from that offered by the NPV method, the advice offered by the NPV method would be preferred. The calculated return on capital employed of 25% is less than the target return of 30%, but as indicated earlier, the investment proposal is financially acceptable as it has a positive NPV. The reason why PV Co has a target return on capital employed of 30% should be investigated. This may be an out-of-date hurdle rate that has not been updated for changed economic circumstances. The discounted payback period of 2·9 years is a significant proportion of the forecast life of the investment proposal of four years, a time period which the information provided suggests is limited by technological change. The sensitivity of the investment proposal to changes in demand and life-cycle period should be analysed, since an earlier onset of technological obsolescence may have a significant impact on its financial acceptability.
Average annual accounting profit = 999,675/4 = $249,919 Average investment = 2,000,000/2 = $1,000,000 Return on capital employed = 100 x 249,919/1,000,000 = 25% (iv) Calculation of discounted payback Year 0 1 2 3 4 $ $$$ $ PV of cash flows (2,000,000) 509,040) 574,919) 1,014,430 268,333 Cumulative PV (2,000,000) (1,490,960) (916,041) 98,389 366,722 Discounted payback period = 2 + (916,041/1,014,430) = 2 + 0·9 = 2·9 years (c) Discuss your findings in each section of (b) above and advise whether the investment proposal is financially acceptable. The investment proposal has a positive net present value (NPV) of $366,722 and is therefore financially acceptable. The results of the other investment appraisal methods do not alter this financial acceptability, as the NPV decision rule will always offer the correct investment advice. The internal rate of return (IRR) method also recommends accepting the investment proposal, since the IRR of 18·2% is greater than the 10% return required by PV Co. If the advice offered by the IRR method differed from that offered by the NPV method, the advice offered by the NPV method would be preferred. The calculated return on capital employed of 25% is less than the target return of 30%, but as indicated earlier, the investment proposal is financially acceptable as it has a positive NPV. The reason why PV Co has a target return on capital employed of 30% should be investigated. This may be an out-of-date hurdle rate that has not been updated for changed economic circumstances. The discounted payback period of 2·9 years is a significant proportion of the forecast life of the investment proposal of four years, a time period which the information provided suggests is limited by technological change. The sensitivity of the investment proposal to changes in demand and life-cycle period should be analysed, since an earlier onset of technological obsolescence may have a significant impact on its financial acceptability.
sonali_mfrp_practise_questions.docx