FM - Ch-2 Investment Appraisal

NW Co is considering investing $46,000 in a new delivery lorry that will last for 4 years, after which time it will be sold for $7,000. Depreciation is charged on a straight-line basis. Forecast operating profits/(losses) to be generated by the machine are as follows.

Year $

1 16,500

2 23,500

3 13,500

4 (1,500)

What is the return on capital employed (ROCE) for the lorry (using the average investment method, to the nearest %)?

• 49%

• 49.5%

• 48%

• None of the above

NW Co is considering investing $46,000 in a new delivery lorry that will last for 4 years, after which time it will be sold for $7,000. Depreciation is charged on a straight-line basis. Forecast operating profits/(losses) to be generated by the machine are as follows.

Year $

1 16,500

2 23,500

3 13,500

4 (1,500)

Assuming operational cash flows arise evenly over the year, what is the payback period for this investment (to the nearest month)?

• 1 year 7 months

• 2 year 7 months

• 1 year 5 months

• 3 years 2 months

Which of the following are benefits of the ROCE method of investment appraisal?

• It is cash flow based.

• It will not be impacted by a company’s accounting polices

• It is a percentage which, being meaningful to non-finance professionals, helps communicate the benefits of investment decisions

• None of these

SW Co has a barrel of chemicals in its warehouse that it purchased for a project a while ago at a cost of $1,000. It would cost $400 for a professional disposal company to collect the barrel and dispose of it safely.

However, the chemicals could be used in a potential project which is currently being assessed. What is the relevant cost of using the chemicals in a new project proposal?

• $1,000 cost

• $400 benefit

• $400 cost

• Nil

A new project being considered by BLW Co would require 1,000 hours of skilled labour. The current workforce is already fully employed but more workers can be hired in at a cost of $20 per hour. The current workers are paid $15 per hour on a project that earns a contribution of $10 per hour.

What is the relevant cost of labour to be included in the project appraisal?

• $10,000

• $15,000

• $20,000

• $25,000

LW Co has a half empty factory on which it pays $5,000 pa rent. If it takes on a new project, it will have to move to a new bigger factory costing $17,000 pa and it could rent the old factory out for $3,000 pa until the end of the current lease.

What is the rental cost to be included in the project appraisal?

• $14,000

• $17,000

• $9,000

• $19,000

Which of the following is a drawback of the payback period method of investment appraisal?

• It is cash flow based.

• It considers the time value of money

• It doesn't measure the potential impact on shareholder wealth.

• It is profit based.

A company is evaluating an investment project with the following forecast cash flows:

Time 0 1 2 3 4

Cash flow ($m) (6.5) 2.4 3.1 2.1 1.8

Using discount rates of 15% and 20%, what is the internal rate of return of the investment project? (to one decimal place)

• 17.7%

• 17.8%

• 17.6%

• None

EE Co is considering investing in a new 40-year project which will require an initial investment of $50,000 (with zero scrap value) and has a payback period of 20 years. The 40-year project has consistent cash flows each year.

What is the ROCE (using the average investment method, to one decimal place)?

• 6 %

• 5.5 %

• 5 %

• None of the above

An accountant is paid $30,000 per annum and spends 2 weeks working on appraising project Alpha.

Why should the accountant NOT charge half of her month’s salary to the project?

• Because her salary cannot be apportioned

• Because her salary is not incremental

• Because her salary is not a cash flow

• Because her salary is an opportunity cost