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Problem - HB Ltd is evaluating a new 3-year project at a cost of R20 million which is expected to result in increase in sales revenue of R25 million in the first year, R20 million in the second year and R15 million in the third year. The asset is depreciated using straight line method for tax purposes and it is expected that the value of the asset will be zero in year 3. The company expects operating costs to be 60% of the revenue. The company will need to invest R4 million in working capital at the beginning of the project which is recoverable at the end of the life of the project. The residual market value of the project at the end of Year 3 is expected to be R6 million. The required rate of return is 12% and the corporate tax rate is 28%. Round up to the nearest tenth.
REQUIRED -
(a) Estimate the project's incremental cash flows over the life of the project.
(b) Compute the NPV of the project and comment on whether the company should accept the project of not.
(c) Compute the IRR of the project and comment on whether the company should accept the project of not.
(d) Compute the Payback period of the project and comment on whether the company should accept the project of not.
(e) Under what circumstances would NPV and IRR lead to conflicting results?
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