# BHM201 Net Present Value and Accounting Rate of Return: Project Evaluation Assessment 1 Answer

ASSESSMENT 1 : PART D

 Course Name: Bachelor of Hospitality Management Course Code: BHM16 Subject Name: Interpreting and Communicating Financial Information Subject Code: BHM201 Assignment title/Item: Project evaluation – Net Present Value (NPV) & Accounting Rate of Return (ARR) Word Count Limit/Time 250 words Weighting: 5% Aim:The aim of this assessment is to apply a net present value calculation to two different investment options and, using the decision rule for NPV, make a recommendation as to the most financially attractive option.The assessment also requires a short answer response detailing some of the non-financial factors which should be considered when deciding between investment options. Task detail:Accor Investments has just purchased the Mantra Lorne Resort, and is proposing to invest \$350,000 to upgrade some of the resort facilities. The General Manager has completed her research, and has come up with two projects – one to renovate the resort Café; and the other is to install a new gym next to the indoor swimming pool. As the only gym in Lorne, Mantra plan to sell memberships to those people who live in town, as well as charging guests who are staying at the Resort. Each project will cost \$350,000. The General Manager must choose ONE of the two projects.Both projects have an estimated life of 5 years.The Café renovation has a salvage (residual) value of \$125,000The gym has a salvage value of \$150,000.The table below outlines the estimated increases in profit and cash flows that would result from each of the options.
 Questions (Total = 20 marks):a. Calculate the:Accounting Rate of Return for both the Café and gym projectsNet Present Value (NPV) for both the Café and gym projects(For NPV, the required rate of return is 12%. Use the discount factors from the table below).(6 + 10 = 16 marks)b. Using your results for the NPV project evaluation method, apply the decision rule to suggest which project makes more financial sense. (2 marks)c. Outline two (2) weaknesses of using the Accounting Rate of Return (ARR) for determining which project to invest in.(2 marks)

ASSESSMENT 1: PART D

Project evaluation – Net Present Value (NPV) & Accounting Rate of Return (ARR)

1. i)  Accounting Rate of Return for both the Café and gym projects

ARR is the measure of return with respect to the initial investment cost. It is calculated as the percentage of average annual profit to initial investment.

 Increased profit Year Café Gym 1 \$64,000 \$25,000 2 \$49,000 \$35,000 3 \$34,000 \$55,400 4 \$19,000 \$72,400 5 \$19,000 \$50,000 Average Annual profit \$37,000 \$47,560 Initial Investment \$350,000 \$350,000 ARR 10.57% 13.59%

ii) Net Present Value (NPV) for both the Café and gym projects

 café Gym Year PV Factor @ 12% Net cash flows PV of cash flows Net cash flows PV of cash flows 1 0.89286 \$101,000 \$90,179 \$47,000 \$41,964 2 0.79719 \$91,000 \$72,545 \$61,000 \$48,629 3 0.71178 \$71,000 \$50,536 \$73,000 \$51,960 4 0.63552 \$63,000 \$40,038 \$93,000 \$59,103 5 0.56743 \$45,000 \$25,534 \$120,000 \$68,091 5 (salvage value) 0.56743 \$125,000 \$70,928 \$150,000 \$85,114 Total cash inflows \$496,000 \$349,760 \$544,000 \$354,862 Initial Investment 1.0000 \$350,000 \$350,000 \$350,000 \$350,000 NPV (PV of inflows - PV of investment) -\$240 \$4,862

1. b. Using your results for the NPV project evaluation method, apply the decision rule to suggest which project makes more financial sense.

The NPV evaluation method uses the present value of cash flows to evaluate the investment. The NPV is = Present value of cash inflows – PV of cash outflows

The project is profitable and should be accepted if the NPV is more than Zero. This shows that the project will add to the net worth of the organization. At NPV zero the project will result in break-even point with no profit and loss. At NPV less than Zero the project will reduce the net worth of the organization and hence should not be accepted (CFI-NPV, 2020).

From the above table it is seen that NPV of café is -\$240 and NPV of Gym, is \$4,862. Since the NPV of Gym is positive and NPV of café is less than Zero, Investment in Gym is profitable should be acceptable.

1. c. Outline two (2) weaknesses of using the Accounting Rate of Return (ARR) for determining which project to invest in.