QUESTION TWO

Zoey Limited is considering upgrading its plant. The financial details of the investment proposal are as follows:

Cost of plant                             R3 600 000

Import duty                              R 900 000

Installation cost                       R 300 000

Net cash flows Year 1-10       R1 400 000 per annum (excluding residual value)

Residual/scrap value              R1 200 000

The company uses straight-line depreciation. The cost of capital for projects of similar risk is 18%.

Ignore taxation.

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 40%.

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.

2.5 Discuss whether the advantages of using the NPV method outweigh the disadvantages