22 answer cumulative cash inflows year project a

  • No School
  • AA 1
  • Rozi.93
  • 20

This preview shows page 11 - 17 out of 20 pages.

22 ANSWER: Cumulative cash inflows: Year Project A Project B 1 140000 20000 2 220000 60000 3 280000 120000 4 300000 220000 5 320000 400000 PBPA = 2 + (240000-220000) / 60000 = 2 + .3333 = 2.33 years PBPB = 4 + (240000-220000) / 180000 = 4 + .1111 = 4.11 years Decision: Project A is better than project B
Image of page 11

Subscribe to view the full document.

12 23 Advantages and disadvantages of payback Advantages include: • it is simple • it is useful in certain situations: – rapidly changing technology – improving investment conditions • it favours quick return: – helps company growth – minimises risk – maximises liquidity • it uses cash flows, not accounting profit. Disadvantages include: • it ignores returns after the payback period • it ignores the timings of the cash flows • it is subjective – no definitive investment signal • it ignores project profitability. 24 Accounting rate of return (ARR) some time called ROCE A comparison of the profit generated by the investment with the cost of the investment Average annual profits before interest and tax ARR = -------------------------------------------- Initial cost of investment or alternatively: Average annual profits before interest and tax ARR = -------------------------------------------- Average capital investment Initial investment + scrap value Average capital investment = ––––––––––––––––––––––––––– 2
Image of page 12
13 25 Accounting rate of return (ARR) some time called ROCE e.g. An investment is expected to yield cash flows of £10,000 annually for the next 5 years The initial cost of the investment is £20,000 Total profit therefore is: £30,000 Annual profit = £30,000 / 5 = £6,000 ARR = 6,000/20,000 x 100 = 30% A worthwhile return? 26 Test your understanding ROCE A project involves the immediate purchase of an item of plant costing $110,000. It would generate annual cash flows of $24,400 for five years, starting in Year 1. The plant purchased would have a scrap value of $10,000 in five years, when the project terminates. Depreciation is on a straight-line basis. Determine the project's ROCE using: (a) initial capital costs (b) average capital investment
Image of page 13

Subscribe to view the full document.

14 27 Test your understanding ROCE Annual cash flows are taken to be profit before depreciation. Average annual depreciation = ($110,000 – $10,000) ÷ 5 = $20,000 Average annual profit = $24,400 – $20,000 = $4,400 Using initial cost: ROCE = Average annual profit ––––––––––––––––– × 100% Initial capital cost $4,400 = –––––––––––– × 100% $110,000 = 4% 28 Test your understanding ROCE Using average capital investment: Average annual profits (as before) = $4,400 Average book value of assets = (Initial capital cost + Final scrap value) ÷ 2 = ($110,000 + $10,000) ÷ 2 = $60,000 ROCE = $4,400 ÷ $60,000 × 100% = 7.33%
Image of page 14
15 29 Test your understanding ROCE 30 Test your understanding ROCE
Image of page 15

Subscribe to view the full document.

16 31 Advantages and disadvantages of ROCE Advantages include: • simplicity • links with other accounting measures. Disadvantages include: • no account is taken of project life • no account is taken of timing of cash flows • it varies depending on accounting policies • it may ignore working capital • it does not measure absolute gain • there is no definitive investment signal.
Image of page 16
Image of page 17
  • Fall '19

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes