13.13 Basic. An investment has the following cash inflows and cash outflows: Cash flow per annum Time £000 0 (20000) 14 3000 58 7000 10 (10000) What is the net present value of the investment at a discount rate of 8 per cent? 13.14 Basle. An investment gives the following results: Net present value £000 Discount rate 383 10% (246) 15% What Is the estimated intemal rate of return to the nearest whole percentage? 13.45 Intermediate. Sycney is considering making a monthly investment for her son who will be five years old on his next birthday. She wishes to make payments until his 18th birthday and intends to ay £50 per month into an account yielding an APR of 12.68, per cent. She plans to start making payments into the account the ‘month after her son's fifth birthday. How much will be in the account immediately after the final payment has been made? 13.16 Intermediate. Sydney wishes to make an investment on a monthly basis starting next month for five years. The payments into the fund would be made on the first day of each month. The interest rate will be 0.5 per cent per month. Sydney needs a terminal value of £7000. ‘What should be the monthly payments into the fund to the nearest £?413.22 Advanced: Calculation of payback, ARR and NPV. Stadler is lan ambitious young executive who has recently been appointed to the position of financial ditector of Paradis pic, a small listed company. Stadler regards this appointment as a temporary one, enabling him to gain experience before moving to a larger organization. His intention is to leave Paradis plc in three years’ time, with its share price standing high. As a consequence, he is particularly concerned that the reported profits of Paradis ple should be as high as possible in his third and final year with the company. Paradis ple has recently raised £350 000 from a rights issue, and the directors are considering three ways of using these funds. Three projects (A, B and C) are being considered, each involving the immediate purchase of equipment costing £350 000. One project only can be undertaken, and the equipment for each project will have a useful life equal to that of the project, with no scrap value. Stadler favours project C because itis expected to show the highest accounting profit in the third year. However, he does not wish to reveal his real reasons for favouring project C, and so, in his report to the chairman, he recommends project C because it shows the highest intemal rate of return. The following summary is taken from his report: Net cash flows (£000) Years Internal rate Project 0 1 2 3 4 5 6 7 8 ofretun(%) A 380 100 110 104 112 138 160 180 - 27.5 B 350-40 100 210 260 160 - - - 264 © 380 200 180 240 40 - - - -~ 330 The chairman of the company is accustomed to projects being appraised in terms of payback and accounting rate of return, and he is consequently suspicious of the use of intemal rate of retum as a ‘method of project selection. Accordingly, the chairman has asked for {an independent report on the choice of project. The company’s cost of capital is 20 per cent and a policy of straightline depreciation is used to write off the cost of equipment in the financial statements. Requirements: (a) Calculate the payback period for each project. (3 marks) (b) Calculate the accounting rate of return for each project. (5 marks) (c) Prepare a report for the chairman with supporting calculations indicating which project should be preferred by the ordinary shareholders of Paradis ple. (12 marks) (q) Discuss the assumptions about the reactions of the stock market that are implicit in Stadler's choice of project C. (5 marks) Note: ignore taxation. ICAEW P2 Financial Management13.23 Advanced: Calculation of NPV and IRR, a discussion of the inconsistency in ranking and a calculation of the cost of capital at which the ranking changes. A company is considering which of two ‘mutually exclusive projects it should undertake, The finance director thinks that the project with the higher NPV should be chosen, whereas the managing director thinks that the one with the higher IRR should be undertaken, especially as both projects have the ‘same initial outlay and length of life. The company anticipates a cost of capital of 10 per cent and the net after tax cash flows of the projects are as follows: Project X Project Y (£000) (£000) Year 0 -200 -200 fi 35 218 2 80 10 3 90 10 4 75 4 5 20 3 You are required to: (a) calculate the NPV and IRR of each project; (6 marks) (b) recommend, with reasons, which project you would undertake (if either): (4 marks) (©) explain the inconsistency in ranking of the two projects in view of the remarks of the directors; (4 marks) (@) identify the cost of capital at which your recommendation in (b) would be reversed. (6 marks) CIMA Stage 3 Management Accounting Techniques