Accounting for Managers: Interpreting accounting information for decision-making

SOLUTIONS TO QUESTIONS 431

On a payback basis, the ranking of projects (with preference to the quickest payback)
is C, then A then B. The accounting rate of return method favours B, then A then C.
The NPV method ranks B followed by C then A. The IRR suggests that Project C has
the highest return (as the cash flows are returned more quickly). No absolute prefer-
ence is clear, although Project A is slightly less attractive. As the accounting profits
are likely to be important in terms of satisfying shareholders, this may be the opti-
mum solution.

12.4
123

NPV 1.7 1.1 1.0

Outlay 3.0 2.0 1.5

PI .57 .55 .67

57% 55% 67%

Ranking 2 3 1

Select All Part All

Ranking 1 Project 3 requires £1.5 million

Ranking 2 Project 1 requires £3 million

Ranking 3 Project 2 £0. 5 million available (25% of project)

Total investment £5 million

12.5
Payback period

End of year 4, i.e. £200,000.

Return on investment

12 345

Investment 200 160 120 80 40

Cash flows 45 50 55 50 35

−Depreciation 20% 40 40 40 40 40

Profit 5 10 15 10 − 5

ROI 2.5% 6.25% 12.5% 12.5% −12.5%

Over the 5 years:

Profit £35/ 5 =£7 Investment £200/ 2 =£100

ROI 7/ 100 =7%