question archive Polycorp is considering an investment in new plant of $3

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Polycorp is considering an investment in new plant of $3.15 million. The project will be partially financed with a loan of $2,000,000 which will be repaid over the next five years in equal annual end of year instalments at a rate of 6.25 percent pa. Assume straight-line depreciation over a five-year life, and no taxes.

The projects cash flows before loan repayments and interest are shown in the table below. Cost of capital is 12.65% pa (the required rate of return on the project). A salvage value of $255,000 is expected at the end of year five and is included in the cash flows for year five below. Ignore taxes and inflation. Year Year One Year Two Year Three Year Four Year Five Cash Inflow 890,000 830,000 815,000 910,000 1045,000

You are required to calculate:

(1) The amount of the annual loan repayment and produce a repayment schedule.

(2) NPV of the project (to the nearest dollar)

(3) IRR of the project (as a percentage to two decimal places)

(4) AE, the annual equivalent for the project (AE or EAV) (to the nearest dollar)

(5) PB, the payback and discounted payback in years (to one decimal place)

(6) ARR, the accounting rate of return (gross and net) (to two decimal places)

(7) PI (present value index or profitability index) (to two decimal places)

(8) Is the project acceptable?

You must provide a decision or explanation for each of the methods in parts (2) to (7). Why or why not (provide a full explanation)? Also a brief explanation of your treatment of Salvage Value and Loan Repayments is required.

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