- This topic has 7 replies, 2 voices, and was last updated 3 weeks ago by
.
- Posts
A project being considered would require a machine costing $80,000 which is expected to be scrapped at the end of the project for $4,000. Market research of $8,000 has already been carried out and capitalised as an asset. The project is expected to last for six years and generate net cash inflows of $20,000 for each of the first three years and $15,000 for each of the last three years. Assume that cash flows arise evenly during the year.
Required:
Evaluate the project using:
(i) ROCE;
(ii) ROCE using the average investment approach;
(iii) Payback period.
this is question from ACCA study hub – i am little confused regarding the market research – why it is captitalised in the first place and in the calculation the add to the depreciation and also to the investment would you kindly explain how should be treated and if the question has change for example they only mentioned the market research with mentioned that it has been capitalized should i include it in the calculation ?
While market research costs are capitalised, they should not be included in cash flow calculations for project evaluation.
They are considered to provide future economic benefits.
Once the market research has been conducted and the cost incurred, it becomes a sunk cost and is irrelevant to future decision-making regarding the project.On the other hand Depreciation is added back because it does not represent a cash outflow.
don’t understand, first of all the answer is
Average annual cash inflow = 17500
Average annual depreciation = (80000-4000+8000)/6=14000
ROCE = ?(17500-14000)/88000*100=4%
at is seems they calculate the depreciation of 8000 which is the research and also include it in the investment
even though your sentence that the depreciation should be added back, why is that i am dealing with cash flow figure ,here there should be no depreciation in that figure so when i want to find profit i should just simply ignore it.
or it sound that i didn’t understand the concept at all? please help!Hello, hope you are doing well!
i don’t know how treat the market research when it comes to calculating ROC,forgive my slow mind ^^ what i understand is market research should never be capitalize as it part of research cost.
however, in the question and the answer above they’ve treated as an asset and reduced the cash flow figure by its depreciation to find the profit and then they consider it part of the investment
my question is
– when i want to calculate ROC and the Market research are capitalized – should i treated as above to find profit i should reduce the cash flow by the depreciation and consider it part of the investment?
– if the question doesn’t mention that the market research has been capitalized should i ignore it?
– and if the question ask for NPV calculation should i ignore it?
thank youROCE (Return on Capital Employed)
Average annual cash inflow =
105,000/6=17,500
Average Annual Depreciation:
Depreciation = (Cost of machine – Scrap value + Market research cost) / Project life
As capitaliaed…long term benefits
80,000?4,000 + 8,000)/6=14,000ROCE Calculation:
ROCE = (Average annual cash inflow – Average annual depreciation) / Initial capital investment × 100%
17,500?14,000) / $88,000 × 100% = 4%m(ii) ROCE using the Average Investment Approach
Average Investment:
Average investment = (Initial investment + Scrap value) / 2
Average investment =
80,000+4,000) / 2 = $42,000Using the same average annual profit before interest and tax as above:
ROCE = (Average annual cash inflow – Average annual depreciation) / Average investment × 100%
ROCE = (17,500?14,000) / $42,000 × 100% = 8.33%(iii) Payback Period
Cumulative Cash Flows:
Year 1: $20,000
Year 2: = $40,000
Year 3: = $60,000
Year 4: = $75,000
Year 5: = $90,000
Year 6: = $105,000Payback Calculation:
The initial investment of $80,000 is recovered between Year 4 and Year 5.
80,000?75,000) / $15,000 = 4 years + 0.33 years = approximately 4.33 years.So in answer to your question yes!
You should include it when it mentions capitalisation
Yes you should ignore it if it doesn’t say this as treat as a sunk cost.
However let me give you some advice
Try and make it clear as to what you are asking.
Don’t worry about little things in a question sometimes it isn’t very clear. If it isn’t write down any assumptions if it is a part C question
If it is part a or b it will either be right or wrong
But don’t spend ages on one particular question
It isn’t worth it!thank you so much for the explanation and the advice i will defiantly consider it.
sometime the 2 mark is life or dead point.
- You must be logged in to reply to this topic.