Bates Limited is considering investing in two capital investment projects. The expected capital expenditure and its related cash flows is given in the table below Details Period Project A (K) Project B (K) Cash Expenditure At outset 410,000 500,000 Cash inflow Year 1 140,000 170,000 Cash inflow Year 2 170,000 195,000 Cash inflow Year 3 135,000 180,000 Cash inflow Year 4 110,000 140,000 Your company considers its cost of capital to be 13%. For Project B, assessed as the riskier project of the two, a risk-adjusted cost of capital of 15% is considered appropriate. Base rate is presently 5% and the company pays a margin of 1%, giving an all in borrowing rate of 6%. Inflation is presently 3%. (a) Assess the two projects using the investment appraisal technique of internal rate of return (IRR). (b) State which project you would recommend to your board and explain in detail your reasons. (c) Besides the IRR rule’s scale problem, what other limitations does this investment appraisal technique present for project evaluation?
QUESTION THREE
Bates Limited is considering investing in two capital investment projects. The expected capital expenditure and its related cash flows is given in the table below
|
Details |
Period |
Project A (K) |
Project B (K) |
|
Cash Expenditure |
At outset |
410,000 |
500,000 |
|
|
Year 1 |
140,000 |
170,000 |
|
Cash inflow |
Year 2 |
170,000 |
195,000 |
|
Cash inflow |
Year 3 |
135,000 |
180,000 |
|
Cash inflow |
Year 4 |
110,000 |
140,000 |
Your company considers its cost of capital to be 13%. For Project B, assessed as the riskier project of the two, a risk-adjusted cost of capital of 15% is considered appropriate. Base rate is presently 5% and the company pays a margin of 1%, giving an all in borrowing rate of 6%. Inflation is presently 3%.
(a) Assess the two projects using the investment appraisal technique of
(b) State which project you would recommend to your board and explain in detail your reasons.
(c) Besides the IRR rule’s scale problem, what other limitations does this investment appraisal technique present for project evaluation?
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