Engen-Auto Limited (Ltd) is a manufacturer of automotive engine parts. The company is considering upgrading its machinery. The financial details of the investment proposal are as follows: Cost of equipment 2 000 000 Import duty 450 000 Installation cost 125 000 Net cash flows Year 1-9 800 000 per annum Year 10 375 000 Residual/scrap value (end of year 10) 525 000 The company uses straight-line depreciation. The cost of capital for projects of similar risk is 20%. Ignore taxation. Required: 2.1 Calculate the investment’s Accounting Rate of Return (ARR). 2.2 Briefly explain if the ARR is acceptable or not based on a target rate of return of 35%. 2.3 Assume a payback period of 4 years. Determine the payback period and state if the investment is acceptable or not. 2.4 Calculate and comment on the viability of the proposed investment based on the net present value (NPV) method.
strong2.1 Calculate the investment’s Accounting Rate of Return (ARR)/strongbr /AstrongInitial Investment/strongstrong2,125,000/strongbr /BstrongScrap Value/strongstrong525,000/strongbr /CstrongUseful Life in Year/strongstrong10/strongbr /DstrongNet Cash Inflow/strongstrong7,575,000/strongbr /DstrongAnnual Depreciation = A-B/C/strongstrong160,000/strongbr /EstrongAverage Accounting Profit (A-D)/strongstrong7,415,000/strongbr /FstrongAccounting Rate of Return (E/A)/strongstrong3.49/strongbr /2.2 Payback Periodbr /Where,br /Years before full recovery : 4 yearbr /Unrecovered cost at start of year : 275000br /Cash flow during the year : 800000br / br /Payback Period : 4 + (-275000/800000)br / : 4-0.34br / : 3.66br /stronguComments:/u/strongbr /The payback period for this project is 3.66 years which is lower than the maximum desired payback period of the management (4 years). The investment in this project is therefore desirable and the investment proposal is acceptable.