Seminar – Question 1 Gamma Ltd is considering the selection of one of two mutually exclusive investment projects. The two projects would involve purchasing machinery with a life of 4 years. Project A would generate annual cash flows (receipts less payments) of £160,000; the machinery would cost £445,000 and have a scrap value of £45,000. Project B would generate annual cash flows of £400,000; the machinery would cost £1,293,000 and have a scrap value of £241,000. Gamma Limited uses the straight-line method of providing for depreciation. Its cost of capital is 14% per annum. Ignore taxation. Required: (1.) Calculate for each project: (i) the ARR to the nearest 1%. (ii) the NPV (iii) the IRR to nearest 1% (iv) the payback period to one decimal place (2.) Identify which project you would select for acceptance, if either, giving reasons for your choice of criterion that led to your decision.

Seminar – Question 2 Company ABC is considering a ₤200,000 outlay for fixed capital items. This outlay includes ₤25,000 for land, plus ₤175,000 for equipment. Depreciation policy is straight-line to zero after five years. Capital allowance/Tax Writing Down Allowance is 20% per annum. The project requires ₤50,000 of current assets and ₤30,000 in current liabilities at the onset.   In Year 1, sales will be ₤220,000. They grow at 25% for the next two years and then grow at 10% for the last two years. Fixed cash operating expenses will be ₤30,000 for Years 1-3 and ₤20,000 for Years 4-5. Variable cash operating expenses are 30% of sales in Year 1, 40% of sales in Year 2 and 35% of sales in Years 3 to 5. Company X’s marginal tax rate is 30% and required rate of return is 10%. At the end of year 5, the company will sell off the fixed capital investments for ₤50,000 and recapture its cumulative investment in net working capital. Income taxes will be paid on any gains. Assume that all cash flows arise at the end of the year. Required: Determine whether this project is profitable using the NPV.

Seminar – Question 3 Delta plc is a huge conglomerate. Its head office corporate finance staff are currently evaluating investment proposals put forward by various divisions for approval. The Electrical division have put forward a proposal to manufacture a new type of transformer which because of rapid technological change, can only be expected to have a 4 –year life, once the production facilities have been set up during the first 12 months. The Building division are proposing to take a four-year lease on a building that already has a tenant paying an annual rent. The Quarry division propose to spend £1.5 million developing a small granite quarry. The quarry would have a 3-year life. At the end of that time, the environmental damage the company caused would need to be rectified at a cost of £0.75 million. The net cash flows of the projects (excluding working capital) are as follows (£000s): Year Electrical Building Quarry 0 -1,000 -1000 -1500 1 -1,000 +200 +500 2 +800 +400 +1000 3 +800 +400 +800 4 +800 +400 -750 5 +800 Delta plc normally uses payback to evaluate projects with a decision criteria of 3 years. Required: Calculate the payback of all three projects and determine the decision advice. If the Electrical and Building division projects were mutually exclusive, which project would you advise the company to accept and justify your decision? If the Building and Quarry division projects were mutually exclusive, which project would you advise Delta plc to accept and justify your decision? Comment briefly on the Delta plc’s use of the same decision criteria for projects from all three divisions. Do you think it is wise?