question archive The management of ABC Ltd anticipates purchasing one of the pump models below
The management of ABC Ltd anticipates purchasing one of the pump models below
Subject:BusinessPrice:4.87 Bought7
The management of ABC Ltd anticipates purchasing one of the pump models below. Each model has an initial cost outlay of Ksh 15,000 and a useful life of 5 years. The corporation tax rate is 30% and the required rate of return is 10%. The pumps are depreciated using straight line method. The before tax and depreciation cash flows expected to be generated by the projects are as follows:
Year
1
2
3
4
5
Model I
8,000
8,000
6,000
5,000
4,000
Model II
6,000
6,000
6,000
6,000
6,000
Year
1
2
3
4
5
Model I
8,000
8,000
6,000
5,000
4,000
Model II
6,000
6,000
6,000
6,000
6,000
Required:
a) Determine the cash flows after tax
b) Compute the AAR, PBP, NPV, PI and IRR for each project
c) Advice the management on the pump model to purchase
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Answer:
a) Refer to attachment below. Row final cash flow represent CF after tax.
b) Refer to attachment:
c) Management should invest in Model I as it is better that Model II in all respects. It has as better average accounting return (35% vs 34%), lesser payback period (2.39 yrs vs 2.94 yrs), higher NPV ( 5415 vs 4333), better profitability index (1.36 vs 1.28) and higher IRR (25% vs 21%)
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