## Quantitative factors - numerical questions (1)

#### Question 1

A company is faced with the choice between two projects X and Y. The cost information for the two projects is summarised below.

X Project Y
600 Capital cost (\$000) 900
Net cash inflow (\$000)
50 Year 1 150
100 Year 2 300
300 Year 3 500
300 Year 4 300
200 Year 5 250
50 Year 6 100

N.B. There are no residual values

(i) For each project determine the payback period and the average rate of return.

The firm has a screening tests of a maximum of 3.0 years for payback period and 12 % as the minimum rate for the average rate of return.

(ii) Explain the meaning of the term 'screening test'.

The firm has a company screening test of 10% for all projects after adjustment for the time value of money.

(iii) Explain the term 'time value of money.

(iv) Calculate the net present value for the best project found in i). Does this meet the firm's screening test?

Use the following discount factors (10% discount rate):

Year 1 0.909
Year 2 0.826
Year 3 0.751
Year 4 0.683
Year 5 0.621
Year 6 0.564

#### Hertford Chemicals plc

Hertford Chemicals plc is considering investing in a new chemical processing plant, but has the choice of manufacturing one of two products on it. The firm requires a minimum return of 20% on any capital expenditure. Details of the two proposals are summarised below:

Project A Initial capital cost Project B
\$200,000 \$250,000
Net cash inflows
\$50,000 Year 1 \$20,000
\$100,000 Year 2 \$150,000
\$200,000 Year 3 \$250,000
\$200,000 Year 4 \$100,000
\$100,000 Year 5 \$150,000

(a) Calculate the payback period, average rate of return and the net present value for the two projects.

Use the following discount factors (20% discount rate):

Year 1 0.833
Year 2 0.694
Year 3 0.579
Year 4 0.482
Year 5 0.402

(b) On the basis of these measures only, which project would you recommend?

(c) What other factors, other than quantitative/financial factors, should you take into consideration when deciding between projects?