Broll Namibia Ltd is considering two expansion projects in Windhoek. Both projects will last for four (4) years and are similar in nature except for their cash flows. Both projects cost NS46 million to kickstart and no additional working capital is required. According to the managing director, Mr. Marco Wenk, only one of these projects will be chosen and funded using debt. The cost of capital is 12% but Mr. Wenk indicated that it may fall to below 12% if additional debt is raised. In addition to this information, Mr. Wenk provided the following estimates to help you evaluate and recommend the appropriate project for the company.
|
| Profit after depreciation | |
|
| Project A | Project B |
|
| N$000 | N$000 |
| Year 0 | 46 000 | 46 000 |
| Year 1 | 6 500 | 4 500 |
| Year 2 | 3 500 | 2 500 |
| Year 3 | 13 500 | 4 500 |
| Year 4 | (1 500) | 14 500 |
| Estimated scrap value at the end of year 4 | 4 000 | 4 000 |
Required:
You are required to evaluate the two projects by calculating the following:
a) The payback period
b) The net present value (NPV)
c) The accounting rate of return (ARR)
d) Explain which of the two projects the company should invest in
e) Assume the two projects had different life spans. Explain what approach Broll would use to
decide on which project to invest in.
f) State three conditions under which the IRR and the NPV techniques may produce different
results
