The task below has been answered for A, B, C - I need answers only for D Flyers plc operates public transport services in major cities in the United Kingdom(UK). The company uses the accounting rate of return (ARR) and payback methods to support investment decision making. You are a Senior Finance Manager at Flyers plc. The company intends to bid for new five-year contracts to operate bus services in either Edinburgh, UK, or Newcastle upon Tyne, UK. Both contracts require the successful bidder to pay a franchise fee to secure the contract and to invest in a new fleet of buses. Sufficient funding is available to finance only one of these options. Edinburgh Newcastle £000 £000 Franchise fee (year 0 ) 8,700 7,950 New buses (year 0) 4,120 3,890 Scrap Value (year 5) 110 95 Forecast net cash inflows Year 1 3,780 3,500 Year 2 4,150 3,850 Year 3 4,550 4,200 Year 4 5,120 5,150 Year 5 4,900 4,950 Assume that all cash flows occur at the end of the respective year. The company’s approach to investment appraisal was discussed at a recent meeting of Flyers plc’s senior executive team. Chang Ying Simmonds, Director of Marketing at Flyers plc, is keen to understand the nature of investment decisions. Chang Ying has commented: These decisions appear to have particular characteristics. We need to understand why investment decisions are of importance to the business as this will help us to appreciate if our approach to investment appraisal is appropriate. Travis van Riemsdyk, Chief Operating Officer at Flyers plc, has highlighted that the internal rate of return (IRR) method can be of use in investment appraisal. Travis has commented: Like other investment appraisal methods, the IRR has both advantages and disadvantages. I would like to know more about the strengths and weaknesses of the IRR. (a) Calculate the payback period for both the Edinburgh and Newcastle upon Tyne contracts. answer Image 1 The payback period of Edinburgh is 3.045 years. The payback period of New Castle is 3.038 years. (b) Calculate the accounting rate of return (ARR) for both contracts. Assume that the only difference between cash flow and profit is the depreciation charge. answer Image 2 The ARR for Edinburgh is 15.27% The ARR for New Castle is 16.73% (c) Critically evaluate the payback technique. answer The general rule of the payback period is to accept those projects with the shortest payback period. The general rule of ARR is to accept those projects with the highest ARR. Edinburgh has a payback period of 3.045 years and an ARR of 15.27%. New Castle has a payback period of 3.038 years and an ARR of 16.73%. New Castle has the shortest payback period and the highest ARR. Therefore, New Castle should be accepted. Required: D) Advise Flyers plc’s senior executive team on the comments made by Chang Ying Simmonds and Travis van Riemsdyk. Your advice should include an explanation of the characteristics of investment appraisal decisions and the advantages and disadvantages of the IRR.

The task below has been answered for A, B, C - I need answers only for D Flyers plc operates public transport services in major cities in the United Kingdom(UK). The company uses the accounting rate of return (ARR) and payback methods to support investment decision making. You are a Senior Finance Manager at Flyers plc. The company intends to bid for new five-year contracts to operate bus services in either Edinburgh, UK, or Newcastle upon Tyne, UK. Both contracts require the successful bidder to pay a franchise fee to secure the contract and to invest in a new fleet of buses. Sufficient funding is available to finance only one of these options. Edinburgh Newcastle £000 £000 Franchise fee (year 0 ) 8,700 7,950 New buses (year 0) 4,120 3,890 Scrap Value (year 5) 110 95 Forecast net cash inflows Year 1 3,780 3,500 Year 2 4,150 3,850 Year 3 4,550 4,200 Year 4 5,120 5,150 Year 5 4,900 4,950 Assume that all cash flows occur at the end of the respective year. The company’s approach to investment appraisal was discussed at a recent meeting of Flyers plc’s senior executive team. Chang Ying Simmonds, Director of Marketing at Flyers plc, is keen to understand the nature of investment decisions. Chang Ying has commented: These decisions appear to have particular characteristics. We need to understand why investment decisions are of importance to the business as this will help us to appreciate if our approach to investment appraisal is appropriate. Travis van Riemsdyk, Chief Operating Officer at Flyers plc, has highlighted that the internal rate of return (IRR) method can be of use in investment appraisal. Travis has commented: Like other investment appraisal methods, the IRR has both advantages and disadvantages. I would like to know more about the strengths and weaknesses of the IRR. (a) Calculate the payback period for both the Edinburgh and Newcastle upon Tyne contracts. answer Image 1 The payback period of Edinburgh is 3.045 years. The payback period of New Castle is 3.038 years. (b) Calculate the accounting rate of return (ARR) for both contracts. Assume that the only difference between cash flow and profit is the depreciation charge. answer Image 2 The ARR for Edinburgh is 15.27% The ARR for New Castle is 16.73% (c) Critically evaluate the payback technique. answer The general rule of the payback period is to accept those projects with the shortest payback period. The general rule of ARR is to accept those projects with the highest ARR. Edinburgh has a payback period of 3.045 years and an ARR of 15.27%. New Castle has a payback period of 3.038 years and an ARR of 16.73%. New Castle has the shortest payback period and the highest ARR. Therefore, New Castle should be accepted. Required: D) Advise Flyers plc’s senior executive team on the comments made by Chang Ying Simmonds and Travis van Riemsdyk. Your advice should include an explanation of the characteristics of investment appraisal decisions and the advantages and disadvantages of the IRR.

Essentials Of Investments

11th Edition

ISBN:9781260013924

Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.

Chapter1: Investments: Background And Issues

Section: Chapter Questions

Problem 1PS

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The task below has been answered for A, B, C - I need answers only for D

Flyers plc operates public transport services in major cities in the United Kingdom(UK). The company uses the accounting rate of return (ARR) and payback methods to support investment decision making. You are a Senior Finance Manager at Flyers plc.
The company intends to bid for new five-year contracts to operate bus services in either Edinburgh, UK, or Newcastle upon Tyne, UK. Both contracts require the successful bidder to pay a franchise fee to secure the contract and to invest in a new fleet of buses. Sufficient funding is available to finance only one of these options.

	Edinburgh	Newcastle
	£000	£000
Franchise fee (year 0 )	8,700	7,950
New buses (year 0)	4,120	3,890
Scrap Value (year 5)	110	95
Forecast net cash inflows
Year 1	3,780	3,500
Year 2	4,150	3,850
Year 3	4,550	4,200
Year 4	5,120	5,150
Year 5	4,900	4,950

Assume that all cash flows occur at the end of the respective year.
The company’s approach to investment appraisal was discussed at a recent
meeting of Flyers plc’s senior executive team. Chang Ying Simmonds, Director of
Marketing at Flyers plc, is keen to understand the nature of investment decisions.
Chang Ying has commented:
These decisions appear to have particular characteristics. We need to understand
why investment decisions are of importance to the business as this will help us to
appreciate if our approach to investment appraisal is appropriate.
Travis van Riemsdyk, Chief Operating Officer at Flyers plc, has highlighted that the
internal rate of return (IRR) method can be of use in investment appraisal. Travis
has commented:
Like other investment appraisal methods, the IRR has both advantages and
disadvantages. I would like to know more about the strengths and weaknesses of
the IRR.

(a) Calculate the payback period for both the Edinburgh and Newcastle upon Tyne contracts.

answer

Image 1

The payback period of Edinburgh is 3.045 years.
The payback period of New Castle is 3.038 years.

(b) Calculate the accounting rate of return (ARR) for both contracts. Assume that the only difference between cash flow and profit is the depreciation charge.

answer

Image 2

The ARR for Edinburgh is 15.27%
The ARR for New Castle is 16.73%

answer

The general rule of the payback period is to accept those projects with the shortest payback period.
The general rule of ARR is to accept those projects with the highest ARR.
Edinburgh has a payback period of 3.045 years and an ARR of 15.27%.
New Castle has a payback period of 3.038 years and an ARR of 16.73%.

New Castle has the shortest payback period and the highest ARR. Therefore, New Castle should be accepted.

Required:

D) Advise Flyers plc’s senior executive team on the comments made by Chang Ying Simmonds and Travis van Riemsdyk. Your advice should include an explanation of the characteristics of investment appraisal decisions and the advantages and disadvantages of the IRR.

E
F G
H
K
MI
Edinburgh
Cumulative CF
2
New Castle
Cashflow
Cashflow
O -€11,745.00 -£
3
Year
Year
Cumulative CF
4
0 -€12,710.00 -£
12,710.00
11,745.00
Workings:
1 £ 3,500.00 -£
2 £ 3,850.00 -£
3 £ 4,200.00 -£
5
1 £ 3,780.00 -£
8,930.00
8,245.00
Investment = Franchise fee + New buses
2 £ 4,150.00 -£
3 £ 4,550.00 -£
6
4,780.00
4,395.00
7
230.00
195.00
Edinburgh Initial Investment = 8700+4120
8
4 £ 5,120.00 £
4,890.00
4 £ 5,150.00 £
4,955.00
Edinburgh Initial Investment = 12,820
9
5 £ 4,900.00 £
9,790.00,
5 £ 4,950.00 £
9,905.00,
10
New Castle lInitial Investment = 7950+3890
ARR
15.27% ((4500-2542)/12820)*100
ARR
16.73% ((4330-2349)/11840)*100
New Castle Initial Investment = 11,840
18
19
[(Cashflow-depreciation)/Investment] * 100
[(Cashflow-depreciation)/Investment] * 100
20
21
Workings:
Workings:
Edinburgh Annual cashflow = (3780+4150+4550+5120+4900)/5
22
Annual depreciation = (Franchise fee + New buses - Scrap value)
23
Edinburgh Annual cashfllow = 4500
Edinburgh Annual depreciation = (8700+4120-110)/5
Edinburgh Annual depreciation = 2542
24
New Castle Annual cashflow = (3500+3850+4200+5150+4950)/5
25
26
New Castle Annual cashflow = 4330
27
New Castle Annual depreciation = (7950+3890-95)/5
%3D
28
New Castle Annual depreciation = 2349
29

A
D
F
H
1
Edinburgh
Cashflow
0 -£12,710.00 -£
1 £ 3,780.00 -£
2 £ 4,150.00 -£
3 £ 4,550.00 -£
4 £ 5,120.00 £
5 £ 4,900.00 £
2
New Castle
Cumulative CF
|Cashflow
0 -£11,745.00 -£
1 £ 3,500.00 -£
2 £ 3,850.00 -£
3 £ 4,200.00 -£
4 £ 5,150.00 £
5 £ 4,950.00 £
3
Year
Year
Cumulative CF
4
12,710.00
11,745.00
8,930.00
8,245.00
4,780.00
4,395.00
7
230.00
195.00
8
4,890.00
4,955.00
9
9,790.00.
9,905.00.
10
Payback Period
3.0449
11
Payback Period
3.0379
12
B7+(-D7/C8)
G7+(-17/H8)
13
Workings:
Initial Investment = Cash outflow - Scrap value
14
15
16
Edinburgh = 8700 + 4120 - 110 = 12,710
17
New Castle = 7950 + 3890 - 95 = 11,745
18

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