Question 4:

Brookfield Company is evaluating two projects Project A and Project B. Capital is available to invest in only one project. Both projects are expected to have a useful life of three years with no residual values. The companys historical Return on Capital Employed (ROCE) is at 9% and the project team assumes it is viable to discount the future cash flows using same rate as the ROCE.

	Project A	Project B
Initial investment	9,000	8,000

The project team has also put together the probabilities as to whether the economic conditions will be good or bad for the next three years. The expected cash flows for the projects along with the probabilities are given below;

		Project A		Project B
Year	Economic condition	Probability	Expected cash flows	Probability	Expected cash flows
1	Good	0.7	3,250	0.7	3,500
	Bad	0.3	2,500	0.3	2,500
2	Good	0.6	4,400	0.6	5,000
	Bad	0.4	3,100	0.4	4,000
3	Good	0.8	4,000	0.8	4,500
	Bad	0.2	2,000	0.2	3,700

Required:

1. Appraise the two alternatives available to Brookfield Company using Net Present Value (NPV).

(10 marks)

2. As the management accountant, which project would you advise the project manager to undertake and why?

(05 marks)

3. If the economic conditions after the first year of the project remain the same for the foreseeable future, what would be the best course of action for Brookfield Company?

(10 marks)

PRESENT VALUE TABLE Present value of $1, that is (1+r)" where r = interest rate; n = number of periods until payment or receipt. Periods (n) 1 2 3 4 5 CO 00 O UNAWN 7 8 9 10 11 12 13 14 15 16 17 18 19 20 1% 0.990 0.980 0.971 0.961 0.951 0.942 0.933 0.923 0.914 0.905 0.896 0.887 0.879 0.870 0.861 0.853 0.844 0.836 0.828 0.820 2% 0.980 0.961 0.942 0.924 0.906 0.888 0.871 0.853 0.837 0.820 0.804 0.788 0.773 0.758 0.743 0.728 0.714 0.700 0.686 0.673 3% 0.971 0.943 0.915 0.888 0.863 0.837 0.813 0.789 0.766 0.744 0.722 0.701 0.681 0.661 0.642 0.623 0.605 0.587 0.570 0.554 4% 0.962 0.925 0.889 0.855 0.822 0.790 0.760 0.731 0.703 0.676 0.650 0.625 0.601 0.577 0.555 0.534 0.513 0.494 0.475 0.456 Interest rates (0) 5% 6% 0.952 0.943 0.907 0.890 0.864 0.840 0.823 0.792 0.784 0.747 0.746 0705 0.711 0.665 0.677 0.627 0.645 0.592 0.614 0.558 0.585 0.527 0.557 0.497 0.530 0.469 0.505 0.442 0.481 0.417 0.458 0.394 0.436 0.371 0.416 0.350 0.396 0.331 0.377 0.312 7% 0.935 0.873 0.816 0.763 0.713 0.666 0.623 0.582 0.544 0.508 0.475 0.444 0.415 0.388 0.362 0.339 0.317 0.296 0.277 0.258 8% 0.926 0.857 0.794 0.735 0.681 0.630 0.583 0.540 0.500 0.463 0.429 0.397 0.368 0.340 0.315 0.292 0.270 0.250 0.232 0.215 9% 0.917 0.842 0.772 0.708 0.650 0.596 0.547 0.502 0.460 0.422 0.388 0.356 0.326 0.299 0.275 0.252 0.231 0.212 0.194 0.178 10% 0.909 0.826 0.751 0.683 0.621 0.564 0.513 0.467 0.424 0.386 0.350 0.319 0.290 0.263 0.239 0.218 0.198 0.180 0.164 0.149