Question: The directors of Mylo Ltd are currently considering two mutually exclusive investment projects. Both projects are concerned with the purchase of new plant. The following data are available for each project:
Project 1 Project 2
Cost (immediate outlay) 100 60
Expected annual net profit (loss):
Year 1 29 18
Year 2 (1) (2)
Year 3 2 4
Estimated residual value of plant 7 6
The business has an estimated cost of capital of 10 per cent, and uses the straight-line method of depreciation for all non-current (fixed) assets when calculating net profit. Neither project would increase the working capital of the business. The business has sufficient funds to meet all capital expenditure requirements.
(a) Calculate for each project:
(i) The net present value.
(ii) The approximate internal rate of return.
(iii) The payback period.
(b) State which, if any, of the two investment projects the directors of Mylo Ltd should accept, and why
(c) State, in general terms, which method of investment appraisal you consider to be most appropriate for evaluating investment projects, and why.