1.

If a team of workers, costing $200,000 per year, is diverted to work on a new project then they will
stop work on existing products which earn contribution (ie sales revenue less variable cost) of
$300,000, this contribution will therefore be lost (note that this assumes that labour is a variable
cost).
Required
Calculate the relevant cost associated with using the team of workers on the new project.

2. Brenda and Eddie are considering expanding their restaurant business through an investment in a new
restaurant, the Parkway Diner. Brenda and Eddie have analysed the profit made in the first year and are
concerned that the project could be loss making.
Their Year 1 costs and revenues are forecast as follows:

Year 1 $
Revenue 200,000
Depreciation 25,000
Materials (note 1) 49,000
Labour (note 2) 100,000
Overheads (note 3) 100,000
Profit/(loss) (74,000)

Note. 1. The materials include $12,000 of surplus inventory at cost that Brenda and Eddie have in their
existing restaurants. This inventory has a scrap value of $5,000.
Note. 2. Labour includes 20% of the $50,000 salary of a manager of an existing branch, who will assist the
existing manager of the restaurant in its first year of operation.
Note. 3. This is an allocation of corporate overheads.

Required
Assess the relevant cash flows of the project in the first year to Brenda and Eddie and advise
Brenda and Eddie whether they are right to be concerned.

3. Brenda and Eddie are worried about the length of time it will take for the cash flows from the Parkway
Diner to repay their total investment of $500,000 ($350,000 to take over the business and $150,000 to
refurbish it).
Cash flow projections from the project are estimated as:
Year Operating cash flows
$
1 70,000
2 70,000
3 80,000
4 100,000
5 100,000
6 120,000

After the sixth year, Brenda and Eddie confidently expect that they could sell the business for $350,000.

Required
Calculate the payback period and ROCE for the project.
4. An asset costing $120,000 is to be depreciated over 5 years to a $10,000 residual value. Profits after
depreciation for the 5 years of the project are as follows.
Year 1 2 3 4 5
Profits 12,000 17,000 28,000 37,000 8,000
Required
What is the average accounting rate of return for this project? (Give your answer to the nearest
percentage.)

5. Reina Ltd has the opportunity to invest in two mutually exclusive investments with the following initial
costs and returns of Project A :
$’000
Initial investment (100)
Cash flows Yr 1 50
Yr 2 40
Yr 3 30
Yr 4 25
Yr 5 20
Residual value after the year 5 is $5,000. The cost of capital is 10%.
Required:
Payback period, Discounted payback period, ROCE, NPV and IRR

6. An investor is prepared to invest $10,000 for one year.

7. $8,000 is invested in an account that pays 10% interest pa. Inflation is currently 7% pa.
Find the real return on the investment.

8. Trecor Co. plans to buy a new machine to meet expected demand for a new product, Product T.This
machine will cost $250,000 and will last for four years, at the end of which time it will be sold for $5,000.
Trecor Co. expects demand for Product T to be as follows:
Year 1 2 3 4
Demand (units) 35,000 40,000 50,000 25,000

The selling price for Product T is expected to be $12.00 per unit and the variable cost of production is
expected to be $7.80 per unit. Incremental annual fixed production overheads of $25,000 per year will be
incurred. Selling price and costs are all in cur- rent price terms.
Selling price and costs are expected to increase as follows:

Increase
Selling price of Product T: 3% per year
Variable cost of production: 4% per year
Fixed production overheads: 6% per year
Other information
Trecor Co. has a real cost of capital of 5.7% and pays tax at an annual rate of 30% one year in arrears. It can
claim capital allowances on a 25% reducing balance basis. General inflation is expected to be 5% per year.
Trecor Co. has a target return on capital employed of 20%. Depreciation is charged on a straight-line basis
over the life of an asset.
Required:

(a) Calculate the net present value of buying the new machine and comment on your findings (work to
the nearest $1,000). (10 marks)
(b) Discuss the strengths and weaknesses of internal rate of return in appraising capital investments. (5
marks)
(15 marks)