Question 1
Real Estate Ltd is considering investing in property development, which requires an initial investment of £130,000. The annual cash inflows during years 1-3 are expected to be £40,000 for year 1; £45,000 for year 2 and £52,000 for year 3. The company’s money cost of capital is 6% and inflation is expected to be 3% during the life of the project.
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Required:
a) Calculate the ARR of the project, taking inflation into account.
b) Calculate the (Undiscounted) Payback Period of the project, taking inflation into account.
c) Calculate the NPV of the project using the money cost of capital as the discount rate, and state clearly whether the project should be undertaken.
d) Calculate the NPV of the project using the real rate of return as the discount rate (round up to 2 decimal places), and state clearly whether the project should be undertaken.
e) Discuss the likely impact of your results in parts c) and d) above on Real Estate Ltd.
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