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ACCA Strategic Professional · Advanced Financial Management · Discounted cash flow techniques

Varley plc is appraising a project with an initial outlay of $200,000 now and a single net cash inflow of $242,000 at the end of year 2. The company's cost of capital is 8% per year. Which statement about the project is correct?

The project should be accepted. Its IRR is 10% because 242,000 divided by 200,000 equals 1.21, which is 1.10 squared. Discounting at 8% gives a present value of about $207,500 against a $200,000 outlay, so NPV is about $7,500 and positive.

  1. ANPV is approximately $7,500 and IRR is about 10%, so acceptCorrect
  2. BNPV is approximately $7,500 and IRR is about 21%, so accept
  3. CNPV is negative and IRR is below 8%, so reject
  4. DNPV is approximately $42,000 and IRR is 10%, so accept

Explanation

IRR: 242,000/200,000 = 1.21 = (1+r)^2, so r = 10%. NPV at 8% = 242,000/1.1664 - 200,000 = 207,476 - 200,000 = about $7,476, roughly $7,500. Because IRR 10% exceeds 8% and NPV is positive, accept. The 21% option treats two-year return as an annual rate; the $42,000 option ignores discounting.

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