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Hi Sir, could you please explain how to work this question out (it’s from the mock exam and im not getting the answer correctly and it will only tell you the correct answer but not how its worked out).
Able Ltd is considering a new project :
initial cost – 30,000
expected life – 5 years
estimated scrap value – 20,000additional revenue from project – 120,000 p/year
incremental costs of project – 30,000 p/year
cost of capital = 5 years
Questions :
1.Calculate the accounting rate of return of the project %
2.Calculate the Net Present value of the project .
Thanks 🙂
You have typed the question wrongly – the initial cost is 300,000 (not 30,000).
The cost of capital is 10% (not 5 years).For the accounting rate of return:
The average profit before depreciation is (120,000 – 30,000) = 90,000 p.a.
The average depreciation is (300,000 – 20,000) / 5 = 56,000 p,a,
Therefore the average profit after depreciation – 90,000 – 56,000 = 34,000 p.a.The average investment = (300,000 + 20,000) / 2 = 160,000
Therefore the ARR = 34,000 / 160,000 = 21.25%
For the NPV:
There is a net inflow of 90,000 per year. Discount this by multiplying by the annuity discount factor for 5 years at 10%.
There is a scrap inflow of 20,000 in 5 years time – discount this by multiplying by the normal present value discount factor at 10%.
Have you watched my free lectures on this? The lectures are a complete free course for Paper F2 and cover everything needed to be able to pass the exam well 🙂
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