At a Board meeting to discuss the proposals the following conversations were heard:
Margaret Poulton, the Finance Director, said, “I think that we should calculate the Net Present Value of the project, in order to ascertain if it is worthwhile.”
Samuel Komakech, the HR Director, responded to this as follows, “I have never understood NPV, can’t we use an appraisal method which measures percentage return. I always think it is more straightforward basing financial decisions on percentages.”
The Managing Director , Vitor Leone then said, “Never mind the appraisal method, I have a more fundamental question. We plan on raising the £20 million investment funds through a Corporate Bond issue. Would it be safer to raise the money through an issue of shares and will this impact the returns on the project?”
Working as consultant to Crypton plc, you are required to respond to the following tasks.
Required:
a) Calculate the Expected Net Present Value arising out of the incremental cash flows for the investment. You should also comment on the potential impact of any risk factors attached to variable costs. In addition, related to your calculations, provide a view on the financial acceptability of the project .
b) In order to satisfy Samuel Komakech, calculate the Average Accounting Rate of Return for the investment and briefly comment on your findings. In addition, provide a summary comment with regard to project acceptability, taking account of your calculations in part (a) above.
c) Provide a brief report to Margaret Poulton and Samuel Komakech indicating, with a fulsome rationale, which appraisal method is generally regarded as being the most acceptable. Net Present Value or Accounting Rate of Return?
