QUESTION FOUR

C Land of Grace and Blessing Lid is considering investing in a project for whicn uc

following information is provided.

GHCO00

Initial capital expenditure 75,000

Profit/(losses): 30,000
Year 1
30,000
Year 2
20,000
Year 3
Year 4
(10,000)
Year 5 (10.000)
Ihe life of the project is five years, at the end of which time there is not expected to be a any
150.
salvage value. The cost of capital of the company is estimated at
Required:
(a) Calculate the following and interpret your answer

1)The payback period in years

(ii)The net present value (NPV)

(ii)The accounting rate of return based on average investment.

(17 marks)

(b) Why are the accounting rate of return and payback period methods of investment appraisal
in spite of their theoretical inferiority to the discounted cash flow methods?
popular in practice
(3 marks)

The relevant discount factors at 15% are as follows:

Ycar Discount factor

1 0.870
2 0.756
3 0.658
4 0.572
5 0.497

(Total marks:20)
Q2. ventures to invest the capital
Success Ltd. which is seeking profitable
Abreta has just up set savings.
accumulated during the several years of his work as a public servant through
Abrefa had a
Accountant. Information gathered through
The company has engaged you as a Management is likely to
introduces its new line 'yoryi' the following
survey indicates that if
the company
result:
achieved ifthe price were set at GH¢200.
i Sales of 15,000 units could be
ii. Variable cost will be GH¢175 per unit.
Fixed costs would amount to GH¢75,000 per
annum.
ill.
be 5 years.
iv. The life of the project is expected to
V. The cost of capital is 10%. before production can

additional GH¢300,000 will have to be spent on development

vi. An the
of development cost includes of GH¢200,000 representing
c o m m e n c e . The amount
these personnel were not working
time spent on Research & Development personnel. If
research'.
on this project, they
would devote their time to 'pure
GH¢100,000 immediately. This should be
be purchased for
Vi. Special plant will have to plant is included in the fixed
at the rate of 25%. The depreciation of special
depreciated
costs.

Required
 to the Board
required to report
you a r e
Management Accountant, NPV and
a ) A s the newly engaged is worthwhile using
the
of Success Ltd. indicating whether or not
the project
(14
IRR methods of project appraisal.
marks)
of project appraisal.
b) List three strengths and three weaknesses of the NPV method
(6 marks)
(20 marks)
 /QUESTIONFIVË
Madam Zaafi has just set
up a company to engage in catering services and has approached your
bank for support to finance her start-up. The company recently commissioned the services of a
i m of management consultants at an estimated cost of GH¢10,000. The consulting fim's
report indicates that if the company introduces its new product 'tuo-zaafi' the following is likelY
to result

1. Sales could be made to an estimated 20,000 customers per annum at an average price OI
GH¢200 per customer for a period of four (4) years.

2. Variable cost of GH¢175 will be incurred to serve each customer.

3. Additional fixed costs of GH¢650.000 will need to be spent to acquire machinery in the
tirst year of set up and annual overhead charges will amount to GH¢350,000 per annumn
tor tour years if the project is to be implemented. The machinery will be depreciated over
four years at GH¢150,000 per annum and the balance representing residual value to be
realizedat the end of the fourth year from disposal.
sVOo0
4. The cost of capital for risky start-ups is 20% per annum.

5. An additiona GH¢300,000 will need to be spent on development of a special formula

before productiop can commence. Included in this amount is an amount of GH¢200,000
which represents the time spent on Research & Development personnel. If these staff
were not working on the "tuo-zaafi project, they would devote their time to 'pure
research'.

Required:
You are required to analyze the project presented by Madam Zaafi using Net Present Value
method of capital project appraisal and advise the Bank whether or not it should fund the
project.
(20 marks)