Question: If the projects are mutually exclusive, which project should Prestigious Sdn Bhd invest in? Explain your recommendation with reference to the above appraisal methods.
Prominent Sdn Bhd invested in two projects, project Alpha and project Beta. The projects are independent of each other. The following schedule shows the
| Year | Project Alpha | Project Beta |
| 0 | -10,000 | -10,000 |
| 1 | 5,000 | 1,000 |
| 2 | 4,000 | 2,000 |
| 3 | 2,000 | 2,000 |
| 4 | 2,000 | 3,000 |
| 5 | 1,000 | 6,000 |
The following schedule shows the profit for each project.
| Year | Project Alpha | Project Beta |
| 0 | 0 | 0 |
| 1 | 2,000 | 1,000 |
| 2 | 2,000 | 1,000 |
| 3 | 2,000 | 2,000 |
| 4 | 2,000 | 2,000 |
| 5 | 2,000 | 4,000 |
The discount rate is 10%.
Additional information :
Appraisal method 1:
|
Year |
Project Alpha |
Project Beta |
|
1 |
2,000 |
1,000 |
|
2 |
2,000 |
1,000 |
|
3 |
2,000 |
2,000 |
|
4 |
2,000 |
2,000 |
|
5 |
2,000 |
4,000 |
|
total profit |
10000 |
10000 |
|
average annual profit (total profit / number of years) |
2000 (10000/5) |
2000 (10000/5) |
|
initial investment |
10000 |
10000 |
|
accounting rate of return = average annual profit initial investment * 100 |
20% 200010000 * 100 |
20% 200010000 * 100 |
Additional information:
Appraisal method 2: Payback period :
computation of cumulative
|
Year |
Project Alpha |
cumulative cash inflows of Project Alpha. |
Project Beta |
cumulative cash inflows of Project Beta. |
|
1 |
5,000 |
5000 |
1,000 |
1000 |
|
2 |
4,000 |
9000 |
2,000 |
3000 |
|
3 |
2,000 |
11000 |
2,000 |
5000 |
|
4 |
2,000 |
13000 |
3,000 |
8000 |
|
5 |
1,000 |
14000 |
6,000 |
14000 |
For Project Alpha ,
initial investment of Project Alpha is 10000.
This initial investment of 10000 is recovered between year 2 and 3 as value of 10000 comes 9000 and 11000 as can be seen from cumulative cash inflows of Project Alpha column.
Payback period = 2 years and (10000 - 9000) * 12 months(11000-9000)
Payback period = 2 years and 6 months
Payback period = 2.5 years.
Payback period for Project Alpha is 2.5 years.
For Project Beta ,
initial investment of Project Beta is 10000.
This initial investment of 10000 is recovered between year 4 and 5 as value of 10000 comes 8000 and 14000 as can be seen from cumulative cash inflows of Project Beta column.
Payback period = 4 years and (10000-8000) * 12 months(14000-8000)
Payback period = 2 years and 4 months
Payback period = 2.33 years.
Payback period for Project Beta is 2.33 years.
Additional information:
Appraisal method 3:
|
Year |
Project Alpha (a) |
Project Beta (b) |
present value factor @ 10 % (c) |
present value of Project Alpha (a*c) |
present value of Project Beta (b*c) |
|
0 |
-10,000 |
-10,000 |
1 |
-10,000 |
-10,000 |
|
1 |
5,000 |
1,000 |
0.9091 |
4545.5 |
909.1 |
|
2 |
4,000 |
2,000 |
0.8264 |
3305.6 |
1652.8 |
|
3 |
2,000 |
2,000 |
0.7513 |
1502.6 |
1502.6 |
|
4 |
2,000 |
3,000 |
0.6830 |
1366 |
2049 |
|
5 |
1,000 |
6,000 |
0.6209 |
620.9 |
3725.4 |
|
|
Net Present Value (total) |
|
|
1341 |
-161 |
Question:
If the projects are mutually exclusive, which project should Prestigious Sdn Bhd invest
in? Explain your recommendation with reference to the above appraisal methods.
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