QuestionQuestion

Question 1
Raisins Ltd is considering an investment plan to expand its manufacturing facility. As part of the plan, the management is thinking of investing in a new machinery. The management has
considered and consulted accounting experts to draw upon the annual incremental profits/losses related to the planned investment. The estimation by the accounting experts is as follows:
Year          £’s
Year 1       (11,000)
Year 2          3,000
Year 3          34,000
Year 4          47,000
Year 5          8,000
The management is willing to make an investment of £175,000 in the start of the project. Assume that the investment sum would of nil disposal value after 5 years. It would be written off using the straight-line method. Depreciation has been included in the profit estimates presented above which should be assumed to arise at the end of each year.

Prepare the following
(a) Report on the Net Present Value (NPV) of the investment at a discounted rate of 10%/annum (this is company’s required rate of return). The discount factors are provided as follows:
Year         Discount factors
Year 1          0.909
Year 2          0.826
Year 3          0.751
Year 4          0.683
Year 5          0.621
(b) On the basis on your outcome, comment on the feasibility of the planned investment. Justify your answer.

Question 2
(a) (i) The management of Tissue Ltd is planning to invest £5.2 million. They expect to generate an annual cash inflow of £1.2 million for five years. A straight-line method is used to carry out depreciation. The estimated figures are that the project will generate a scrap value of £420,000 at the end of five years. You are required to calculate the accounting rate of return. Assume that there is no other expense on the project.
(ii) Critically discuss your findings.
(b) Flawless group has recently carried out an assessment of the age of their equipment and found that they have an old machinery that requires replacement with the new one. They have found a potential client for their old machinery who is ready to purchase it for £400,000. It is expected that the new machine will increase annual revenue by £6,000,000. It will also increase annual operating expenses by £2,400,000. The cost of the new equipment is £14,400,000. The useful life of the machine is estimated to be 12 years with zero salvage value. You are required to prepare the following:
(i) Accounting rate of return.
(ii) If management wants to achieve an accounting rate of return of 15% on all capital
investments, should the management go ahead with the purchase. Critically comment on
this.

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QUESTION 1A
Net Present value (NPV) and internal rate of return (IRR) are both discounted cash flow (DCF) methods used to evaluated projects or investments. In long term projects (greater than 12 months), DCF methods are superior to methods that do not account for the time value of money. DCF techniques recognize that the money invested in a project has an opportunity cost- the return foregone from alternative investment. The NPV is the sum of the present values of all project cash flows, as depicted in below formula:
(CPAA study guide material, Strategic Management Accounting, Module 5 Project Management, January 2013 edition)
The following table show the given data and required data to determine the net present value:
Given                               Required
Accounting profit             Cash Inflows
Original investment          Cash Outflows
Discount factor                Discount factor
We are provided with accounting profits instead of Cash Inflows. By definition, Accounting Profits are cash flows that include non-cash inflows/outflows such as depreciation...

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