1102AFE Accounting for Decision Making: Homework 9, Trimester 3, 2019

This homework assignment focuses on investment decision-making using various financial analysis techniques. The student analyzes a hypothetical delivery business investment, calculating and interpreting the Accounting Rate of Return (ARR), Payback Period, and Net Present Value (NPV) to determine the project's financial viability. The solution includes detailed calculations of depreciation, average profit, and average investment for ARR, as well as a payback period analysis. Furthermore, the assignment explores the impact of a required rate of return on the investment decision, using present value factors to determine the NPV. Finally, it assesses the relationship between the Internal Rate of Return (IRR) and the required rate of return, providing a comprehensive evaluation of the investment's potential profitability and financial attractiveness. This assignment is a valuable resource for students studying financial accounting and investment analysis, providing a practical application of key concepts and techniques.

1102AFE ACCOUNTING FOR DECISION MAKING
Trimester 3, 2019
Assessable Homework 9
TOTAL MARKS = 30 marks—divide by 10 to get a % out of 3%
Situation:
You are deciding to start a delivery business in January 2020. The initial investment includes a small
truck which costs $70,000. Other expenses were included in the expected cash flows. The truck has a
useful life of 5 years and an estimated residual value at the end of the 5th year of $10,000 (the amount
expected the truck can be sold). Depreciation is the only non-cash expense.
The net cash flows of each year in the following 5 years are estimated as follows:
Initial investment: $70,000
Net cash flow year 1: (20,000)
Net cash flow year 2: 10,000
Net cash flow year 3: 20,000
Net cash flow year 4: 40,000
Net cash flow year 5: 30,000
Estimated sale of truck year 5: 10,000
Question 1: (10 marks)
If your required rate of return is 8%, what would be your decision based on the accounting rate of
return (ARR)?
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1102AFE ACCOUNTING FOR DECISION MAKING
Trimester 3, 2019
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Total Depreciation =( Initial Investment- Sale Value)
($70000-$10000)=$60000
Average Profit =(Sum of Cash Flow-Depreciation)/ No of years
((-20000+10000+20000+40000+30000)-60000)/5=$4000
Average investment = ( Initial Value+ End Value)/2
(70000+10000)/2
ARR = Average Profit/ Average Investment
= 4000/40000
=10%
Decision? Why?
The project should be accepted when compared with the required rate of return. This is because the
accounting rate of return of the project is 10%, while the required rate of return is 8%. Thus since
the accounting rate of return than the required rate of return, the project will generate value for
the company and is attractive for the company.
The greater the accounting rate of return from the required rate of return, the more attractive is
the project for the company.

1102AFE ACCOUNTING FOR DECISION MAKING
Trimester 3, 2019
Question 2: (9 marks)
If your required payback period is 3 years, what would be your decision based on the payback period?
(calculate the payback period in years rounded using 2 decimals)
Year Cash Flow Accum. Cash flow
0 -70000 -70000
1 -20000 -90000
2 10000 -80000
3 20000 -60000
4 40000 -20000
5 30000 10000
Payback Period = 4+(20000/30000)
= 4.67 years
Decision? Why?
The payback period of a project is the time which would be required by the
company to recover the initial amount which is invested by the company.
Thus the lower the payback period the more faster the company will be able
to recover the initial amount which is invested by the company. Since the
threshold level for the payback period by the company is 3 years. Thus the
payback is greater than the threshold level at 4.67 years, the company
should reject the project. The time which would be required to collect the
investment would be greater than the threshold level of 3 years.
Question 3: (9 marks)
If your required rate of return is 8%, what would be your decision based on the net present value
method (NPV)? Use the table below to calculate NPV.
Question 4: (2
marks)
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Year Cash Flow PV Factor Present Value
Now -70000 1 -70000
1 -20000 0.93 -18518.52
2 10000 0.86 8573.39
3 20000 0.79 15876.64
4 40000 0.74 29401.19
5 30000 0.68 20417.5
NPV -14249.8
Decision? Why?
The company should reject the project since the NPV of the project is negative
14249.8. Thus the project would result in the loss in the value of the company. thus
this would lead to loss in the shareholders wealth and hence the project should be
avoided by the company.

1102AFE ACCOUNTING FOR DECISION MAKING
Trimester 3, 2019
Is the internal rate of return higher, lower or the same as the required rate of return in this business?
Why?
The IRR of the project is less than the required rate of return of 8%. This is because the project has
been providing lesser returns compared to the initial investment of the project. If the project would
have an IRR greater than the required rate of return it would had yielded a positive NPV, which is
not the case. Hence, the project has an IRR, which is less than the required rate of return. The IRR
which is calculated using the cash flow of the project provides a return of 3%, which is less than the
required return of 8%.
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1102AFE ACCOUNTING FOR DECISION MAKING
Trimester 3, 2019
n 1% 2% 3% 4% 5% 6% 8% 10% 12%
1 0.990 0.980 0.971 0.962 0.952 0.943 0.926 0.909 0.893
2 0.980 0.961 0.943 0.925 0.907 0.890 0.857 0.826 0.797
3 0.971 0.942 0.915 0.889 0.864 0.840 0.794 0.751 0.712
4 0.961 0.924 0.888 0.855 0.823 0.792 0.735 0.683 0.636
5 0.951 0.906 0.863 0.822 0.784 0.747 0.681 0.621 0.567
6 0.942 0.888 0.837 0.790 0.746 0.705 0.630 0.564 0.507
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