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Able Ltd is considering a new project for which the following information is available:
Expected life 5 years
Estimated scrap value $20,000
Additional revenue from the project $120,000 per year
Incremental costs from the project $30,000
Cost of capital 10%
Calculate the NPV of this project.
Calculate the Accounting Rate of Return of the project.
Actually I’ve seen someone post the same question after attempting the mock exam but I still wasn’t able to understand the entire thing apart from the part where the incremental cost is subtracted from additional revenue.
I tried discounting but ended up with a wrong answer.
Thank you.
The scrap is an inflow of 20,000 in 5 years time, so discount this using the present value discount factor for 5 years at 10%.
The net cash inflow each year is 120,000 – 20,000 = 90,000 per year for 5 years, so discount this using the annuity factor for 5 years at 10%.
The NPV is the total of the two PV’s above, less the initial investment.
Thank you for replying. I think 53,610 is the answer then and the IRR is probably 17%. I’ve got it.
Also I wanted to know few examples where these incremental costs might be incurred, just for my information because it helps me to grab the concept better.
Thank you once again. Have a good day Sir.
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