Week 10 – Seminar Activity

Question 1: The directors of Mylo Ltd are currently considering two

mutually exclusive investment projects. Both projects are concerned with the
purchase of new plant. The following data are available for each project:

Project 1 Project 2
£000 £000
Cost (immediate outlay) (100) (60)
Expected annual operating profit (loss):
Year 1 29 18
Year 2 (1) (2)
Year 3 2 4
Estimated residual value of the plant 7 6

The business has an estimated cost of capital of 10 per cent, and uses the
straight-line method of depreciation for all non-current assets when
calculating operating profit. Neither project would increase the working
capital of the business.

The business seeks to maximise the wealth of its shareholders, but the directors
are very cautious so only accept projects with a payback period of less
than two years. The directors calculate the accounting rate of return using
the average investment method.

The business has sufficient funds to meet all capital expenditure requirements.

Required:
The project manager has completed the financial project appraisal for
Project 1 and wants you to help her with Project 2.
(a) Calculate for Project 1:
(i) Accounting Rate of Return (ARR)
(ii) Payback Period (PP)
(iii) Net Present Value (NPV)
You may work to the nearest £1,000.
(b) Tabulate your results, the decision criteria and the decision for each
project by completing using the decision table below.
(c) State which, if any, of the two investment projects the directors of Mylo
Ltd should accept, and why.