Stadler is an ambitious young executive who has recently been appointed to the position of financial director of Paradis plc, a small listed company. Stadler, regards this appointment as a temporary one, enabling him, to gain experience before moving to a larger organisation. 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 plc should be as high as possible in his third and final year with the company. Paradis plc has recently raised 6350,000 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 S350,000. 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 it is expected to show the highest accounting profit in the third year. However, be does not wish to reveal his real reasons for favoring project C and so in his report to the chairman, he recommends project C because it shows the highest internal rate of return. The following summary is taken from his report: Year Project A Project B Project C 0 -350,000 -350,000 -350,000 1 100,000 40,000 200,000 2 110,000 100,000 150,000 3 104,000 210,000 240,000 4 112,000 260,000 40,000 5 138,000 160,000 - 6 160,000 - - 7 180,000 - - 8 - - - Internal rate of return for the three projects are A at 27.5%; B at 26.4% and C at 33.0%. The chairman of the company is accustomed to projects being appraised in terms of payback and accounting rate of return, and be is consequently suspicious a the use of internal rate of return 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% and a policy of straight — line depreciation is used to write off the cost of equipment in the financial statements. Required a. Calculate the accounting rate of return for each project. b. Calculate the net present value for each project. c. A report for the chairman with supporting calculations indicating which project should be preferred by the ordinary shareholders of Paradis plc. Your report should critically compare and contrast the salient features a Payback, ARR, IRR and NPV as alternative investment appraisal techniques.
Stadler is an ambitious young executive who has recently been appointed to the position of financial director of Paradis plc, a small listed company. Stadler, regards this appointment as a temporary one, enabling him, to gain experience before moving to a larger organisation. 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 plc should be as high as possible in his third and final year with the company.
Paradis plc has recently raised 6350,000 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 S350,000.
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 it is expected to show the highest accounting profit in the third year.
However, be does not wish to reveal his real reasons for favoring project C and so in his report to the chairman, he recommends project C because it shows the highest
Year Project A Project B Project C
0 -350,000 -350,000 -350,000
1 100,000 40,000 200,000
2 110,000 100,000 150,000
3 104,000 210,000 240,000
4 112,000 260,000 40,000
5 138,000 160,000 -
6 160,000 - -
7 180,000 - -
8 - - -
Internal rate of return for the three projects are A at 27.5%; B at 26.4% and C at 33.0%.
The chairman of the company is accustomed to projects being appraised in terms of payback and accounting rate of return, and be is consequently suspicious a the use of internal rate of return 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% and a policy of straight — line
Required
a. Calculate the accounting rate of return for each project.
b. Calculate the
c. A report for the chairman with supporting calculations indicating which project should be preferred by the ordinary shareholders of Paradis plc. Your report should critically compare and contrast the salient features a Payback, ARR, IRR and NPV as alternative investment appraisal techniques.
Trending now
This is a popular solution!
Step by step
Solved in 3 steps with 4 images
