Mr Cowdrey runs a manufacturing business. He is considering whether to accept one of two mutually exclu- sive investment projects and, if so, which one to accept. Each project involves an immediate cash outlay of
£100,000. Mr Cowdrey estimates that the net cash inflows from each project will be as follows:
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Net cash inflow at end of:
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Project A (£)
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Project B (£)
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Year 1
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60,000
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10,000
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Y ear 2
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40,000
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20,000
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Y ear 3
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30,000
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1 10,000
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Mr Cowdrey does not expect capital or any other resource to be in short supply during the next three years.
Required
(a) Prepare a graph to show the functional relationship between net present value and the discount rate for the two projects (label the vertical axis 'net present value' and the horizontal axis 'discount rate').
( b) Use the graph to estimate the internal rate of r eturn of each p r oject.
(c) On the basis of the information given, advise Mr Cowd r ey which p r oject to accept if his cost of capital is
(i) 6 per cent; (ii) 12 per cent.
( d ) Describe briefly any additional information you think would be useful to Mr Cowd r ey in choosing between the two p r ojects.
(e) Discus s th e r elativ e merit s o f ne t p r esen t valu e an d interna l rat e o f r etur n a s method s o f investment appraisal.