CAPITAL INVESTMENT APPRAISAL

3 Intermediate: Calculation of payback, NPV and ARR for
mutually exclusive projects. Your company is considering investing in
its own transport fleet. The present position is that carriage is contracted
to an outside organization. The life of the transport fleet would be five
years, after which time the vehicles would have to be disposed of.
The cost to your company of using the outside organization for its
carriage needs is £250 000 for this year. This cost, it is projected,
will rise 10 per cent per annum over the life of the project. The initial
cost of the transport fleet would be £750 000 and it is estimated
that the following costs would be incurred over the next five years:
Drivers’ Costs
(£)
Repairs & Maintenance
(£)
Other Costs
(£)
Year 1 33 000 8 000 130 000
Year 2 35 000 13 000 135 000
Year 3 36 000 15 000 140 000
Year 4 38 000 16 000 136 000
Year 5 40 000 18 000 142 000
Other costs include depreciation. It is projected that the fleet would
be sold for £150 000 at the end of year 5. It has been agreed to
depreciate the fleet on a straight line basis.
To raise funds for the project your company is proposing to raise
a long-term loan at 12 per cent interest rate per annum.
You are told that there is an alternative project that could be invested
in using the funds raised, which has the following projected results:
Payback = 3 years
Accounting rate of return = 30%
Net present value = £140 000.
As funds are limited, investment can only be made in one project.
Note: The transport fleet would be purchased at the beginning of the
project and all other expenditure would be incurred at the end of
each relevant year.
Required:
(a) Prepare a table showing the net cash savings to be made by
the firm over the life of the transport fleet project. (5 marks)
(b) Calculate the following for the transport fleet project:
(i) Payback period
(ii) Accounting rate of return
(iii) Net present value (13 marks)