What tasks are involved in the paragraph?
The paragraph describes three capital expenditure projects (A, B, and C) with their respective costs, expected cash inflows, and scrap values. Depreciation is accounted for using straight-line basis. The cost of capital is estimated at 18%. The discount factors for a discount rate of 18% are also provided. The tasks are to calculate the payback period, accounting rate of return, and net present value for each project, and then determine which project should be accepted based on the results. Additionally, an explanation is required on how investment decisions affect the maximization of shareholders' wealth.
Calculating Financial Metrics for Capital Expenditure Projects
Payback Period: The payback period is calculated by determining the time it takes for the cumulative cash inflows to equal the initial investment of each project. The project with the shortest payback period is typically preferred as it indicates a quicker recovery of the initial investment.
Accounting Rate of Return: The accounting rate of return is calculated by dividing the average annual accounting profit by the initial investment and expressing it as a percentage. This metric helps assess the profitability of each project based on accounting figures.
Net Present Value: The net present value is calculated by discounting the expected cash inflows of each project using the provided discount factors for an 18% discount rate. Subtracting the initial investment from the present value of cash inflows gives the net present value. A positive net present value indicates that the project is expected to generate returns above the cost of capital.
Based on these calculations, the project that offers the shortest payback period, highest accounting rate of return, and positive net present value should be accepted. In this case, the project that maximizes shareholder wealth is the one that generates the highest returns relative to the cost of capital, ultimately increasing the overall value of the company and benefiting its shareholders.