Investment appraisal

The Company X. is considering tendering for a local authority contract to supply school snacks. If they decide to tender and are successful, this will be their first contract in the public sector. The contract is for a period of five years.

The company has spent $2,500 on a feasibility study related to this contract. From this study, they have obtained the following estimates of costs, revenues and volumes.

1. The initial cost of the investment for the necessary cooking equipment will be $30,000. This sum will be payable at the beginning of the contract.
2. Selling price of snacks: $1.00 per snack for the first three years, than $1.20 for years four and five.
3. Cost of snacks: $0.60 per snack for the first three years, than $0.70 for years four and five.
4. Rent of premises is estimated to be $2,000 per year.
5. Forecast of the number of meals to be sold:

6. Transport costs: $2,000 per year.
7. The company uses straight-line depreciation and intends to charge $1.500.
8. The company’s cost of capital is 14%.
9. The company expects a payback within four years and its target accounting rate of return is 25%.

You are required to evaluate the investment using the following appraisal methods: net present value, internal rate of return, payback period (undiscounted and discounted) and the accounting rate of return. For each appraisal method, state with reasons whether the project should be accepted or rejected.

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