Question Tag: Capital Budgeting

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  • 5 Marks

SCS – Nov 2024 – L3 – Q4a – Capital Budgeting Framework

Explanation of the five key elements in the capital budgeting framework for investment appraisal.

One of the Board members, Dr. Halimatu Sadia, has expressed concerns regarding Dr. Ayimadu Baffour’s consistent failure to conduct investment appraisals and capital budgeting when making long-term investment decisions.

Required:

Advise Dr. Ayimadu Baffour on the capital budgeting and strategic planning framework used for conducting investment appraisals by briefly outlining the FIVE key elements of the framework.

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  • 15 Marks

MA – Nov 2024 – L2 – Q4a – Cost-Benefit Analysis (CBA) for Public Sector Investment

Evaluation of a healthcare capital investment project using cost-benefit analysis.

The Faith Specialist Hospital (FSH) is a special government health facility under the Ghana Health Service (GHS) that provides specialized medical scans for complex health conditions. Management of FSH is planning to install an ultra-modern imaging machine that will improve the quality and accuracy of scans. The new installation will require an additional capital investment of GH¢420,000. The GHS policy on capital projects is that all new projects should achieve an internal rate of return of at least 30%.

Forecast demand for the services of this new machine over its five-year useful life are as follows:

Year Number of Scans
1 1,250
2 2,700
3 3,500
4 1,400
5 675

Projected charge per scan: GH¢650
Variable costs per scan:

  • Consumables: GH¢330
  • Labour and overheads: GH¢176

Operating fixed costs per year: GH¢264,000 (includes depreciation on a straight-line basis)

Apart from the financial forecasts above, it is also envisaged that the project will produce non-financial benefits in several forms. Although it is hard to place a precise value on this, expert opinion suggests that this could approximate GH¢70,000 per annum.

Required:

i) Using cost-benefit analysis (CBA) computations, evaluate if the project should be undertaken.

ii) Enumerate TWO limitations of evaluating projects in the public sector.

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  • 20 Marks

FM – May 2023 – L3 – Q3 – Investment Appraisal Techniques

Evaluate Tinco Limited's expansion project using financial metrics, assess sensitivity to contribution and tax rate changes, and incorporate capital allowances.

Tinco Limited (TL) is considering an expansion project. The project will involve the acquisition of an automated production machine costing ₦11,000,000 and payable now. The machine is expected to have a disposal value at the end of 5 years, which is equal to 10% of the initial expenditure.

The following schedule reflects a recent market survey regarding the estimated annual sales revenue from the expansion project over the project’s five-year life:

Level of Demand ₦’000 Probability
High 16,000 0.25
Medium 12,000 0.50
Low 8,000 0.25

It is expected that the contribution to sales ratio will be 50%. Additional expenditure on fixed overheads is expected to be ₦1,800,000 per annum. TL incurs a 20% tax rate on corporate profits. Corporate tax is paid one year in arrears.

TL’s after-tax nominal (money) discount rate is 15.5% per annum. A uniform inflation rate of 5% per annum will apply to all costs and revenues during the life of the project. All of the values above have been expressed in terms of current prices.

You can assume that all cash flows occur at the end of each year and that the initial investment does not qualify for capital allowances.

Required:

a.
i. Evaluate the proposed expansion from a financial perspective. (10 Marks)
ii. Calculate and interpret the sensitivity of the project to changes in:

  • The expected annual contribution (3 Marks)
  • The tax rate (2 Marks)

b.
You have now been advised that the capital cost of the expansion will qualify for written down allowances at the rate of 25% per annum on a reducing balance basis. Also, at the end of the project’s life, a balancing charge or allowance will arise equal to the difference between the scrap proceeds and the tax written down value.

You are required to calculate the financial impact of these allowances. (5 Marks)

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  • 10 Marks

PSAF – May 2021 – L2 – Q3b – Fiscal Policy and Public Finance

NPV-based investment recommendation for Omidan Local Government among three projects and a risk-free security alternative.

Omidan Local Government Council has N20,000,000 to invest, if there is an assurance that the investment will earn at least 12% p.a. In view of this, the following projects are being considered:

  • Project A will earn N21,800,000 at the end of year one with a residual value of N1,500,000;
  • Project B will earn N24,000,000 at the end of year two with a residual value of N500,000; and
  • Project C will earn N14,000,000 at the end of year one and another N10,000,000 at the end of year two with no residual value.

If none of the projects is undertaken, Omidan Local Government Council will invest the N20,000,000 in a risk-free security that will earn interest of 12% p.a.

Required:

Assess and advise Omidan Local Government Council on which of the projects to be undertaken using Net Present Value (NPV) method.

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  • 20 Marks

BMF – Nov 2020 – L1 – SB – Q5 – Investment Decisions

Evaluate the investment project using IRR and advise management on the project feasibility.

Uhuru Nigeria Limited wants to buy a new item of equipment which will be used to improve service delivery to its customers. Using the internal rate of return (IRR) method of investment appraisal, you are required to evaluate the project and advise the management of the company. Estimated cash flows from the project are as provided below:

Year Cash Flow (N)
0 (400,000)
1 140,000
2 150,000
3 170,000
4 190,000

The expected minimum required rate of return of the company is fixed at 25%.

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  • 30 Marks

PM – Nov 2015 – L2 – Q1 – Decision-Making Techniques

Comparison of two machine purchase options - ZIGMA 5000 and DELPHA 7000 using profitability statement, cash flows, payback period and NPV.

The Board of Directors of Danda Company Limited is proposing the purchase of either of two machines that have been proved adequate for the production of an engineering product “Gee”. The two machines are: ZIGMA 5,000 and DELPHA 7,000. Production in the first year would be affected by installation challenges and inadequate understanding of the operating instructions of the machines.

Information available from the production profile of the two machines are as shown below:

ZIGMA 5000:

Cost of machine is N16,500,000 while the life span is 6 years.

DELPHA 7000:

Cost of plant is N18,300,000 while the life span is 6 years.

Other information relevant to the company’s operations and administration are:

(i) Selling price per unit is N300.

(ii) Variable cost per unit is N150.

(iii) Annual fixed overhead exclusive of depreciation is N1,200,000.

(iv) Company depreciation policy is straight line basis.

(v) The budgeted production capacity is 100,000 units.

(vi) No opening or closing inventory is envisaged.

(vii) All sales are for cash.

(viii) All costs are for cash.

Required:

a. Prepare the SIX year profitability statement for the two machines. (6 Marks)

b. Prepare the SIX year cash flow statement for the two machines. (6 Marks)

c. What is the payback period for the two machines? (7 Marks)

d. Determine the Net Present Value (NPV) of the two machines if the acceptable discount rate for the company is 15%. (7 Marks)

e. Which of the two machines should the company acquire? (4 Marks)

 

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  • 20 Marks

PM – May 2022 – L2 – SA – Q3 – Performance Evaluation

Evaluate Uzochuks' financial performance using ARR and EVA, and assess the NPV of a solar project.

Uzochuks Nigeria Limited is a company established four years ago to produce medical equipment. The income statement and statement of financial position for 2019 and 2020 are as follows:

(ii) Economic depreciation is assessed to be N50.5million in 2020. Economic depreciation includes any appropriate amortisation adjustments. In previous years, it can be assumed that economic and accounting depreciation were the same.
(iii) Tax is the cash paid in the current year (N16 million) and an adjustment of N2 million for deferred tax provisions. There was no deferred tax balance prior to 2020.
(iv) The provision for doubtful debts was N2.5million on the 2020 statement of financial position.
(v) Research and development is not capitalised in the accounts. It relates to a new project that will be developed over five years and is expected to be of long-term benefit to the company. 2020 is the first year of this project.
(vi) The company had a non-capitalised leased assets of N18million in January 2020. These assets are not subjected to depreciation.
(vii) Cost of capital of Uzochuks:
Equity 18%
Debt (pre-tax) 6%
(viii) Capital structure of Uzochuks:
Equity 60%
Debt 40%
(ix) The company had the opportunity to invest in a solar project that will require the procurement of an equipment worth N3million in January 2020 and run for a period of 5 years with a salvage value of N0.50million, generating a stable net cash flow of N0.85 million. The applicable cost of capital is the associated weighted average cost of capital of the company.

Required:
a. i. Compute and evaluate the company’s performance using the average rate of return (ARR). (4 Marks)
ii. Compute and evaluate the company’s performance using the economic value added (EVA) parameter. (9 Marks)
b. Calculate the net present value (NPV) of a solar project that will require the procurement of equipment worth N3 million in January 2020, generating a stable net cash flow of N0.85 million annually for five years with a salvage value of N0.50 million. The applicable cost of capital is the associated weighted average cost of capital of the company. (7 Marks)

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  • 20 Marks

BMF – Nov 2014 – L1 – SB – Q4 – Investment Decisions

Appraise a proposed investment using the Internal Rate of Return and evaluate the use of the Accounting Rate of Return.

Management decisions regarding the acquisition of non-current assets and other long-term investments involve huge capital outlay, and they are critical to the future profitability and success of the company.

Gboza Limited proposed to buy a plant costing N2,000,000 which is expected to generate annual net cash flow of N600,000 for six years at a cost of capital of 10%.

Required:

a. Appraise the project using the internal rate of return. (13 Marks)
b. Should the plant be purchased? (2 Marks)
c. State TWO advantages and THREE disadvantages of accounting rate of return (ARR) as an investment appraisal technique. (5 Marks)

(Total 20 Marks)

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  • 1 Marks

BMF – Nov 2021 – L1 – SA – Q15 – Investment Decisions

Question about the relevant cost for capital investment decisions.

The concept of cash flow is of vital importance to capital investment appraisal. Which of the following costs is relevant to investment decisions?

A. Future costs
B. Notional costs
C. Committed cost
D. Absorbed cost
E. Apportionment cost

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  • 20 Marks

BMF – May 2021 – L1 – SB – Q4 – Investment Decisions

Evaluate two equipment options using NPV and Discounted Payback Period to maximize shareholder value.

Felfred Limited is contemplating buying a new item of equipment to facilitate the improvement of the quality of services provided to customers of the company. Two models of the needed equipment are currently available in the market. The two machines, Xetoy and Whytox would cost N750,000 and N1,500,000 respectively. Additional information in relation to the two equipment is as stated below:

Equipment Xetoy Whytox
Estimated Lifespan 5 years 5 years
Expected Cash inflows / Year
2021 N500,000 N500,000
2022 N500,000 N500,000
2023 N300,000 N600,000
2024 N200,000 N600,000
2025 N100,000 N600,000
Disposal value N50,000 N100,000

Based on Net Present Value (NPV) and Discounted Payback Period methods of investment appraisal, you are required to select the equipment in which the value of shareholders will be maximised. Costs of installation for Xetoy and Whytox are N50,000 and N100,000 respectively. The company’s minimum required rate of return is currently at 12%.

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  • 20 Marks

BMF – May 2021 – L1 – SB – Q3 – Investment Decisions

Calculate payback periods for two investment projects and decide based on company policy.

CASHIO Limited must choose between two investments, Project ABUWA and Project BRIWA. It cannot undertake both investments. The expected cash flows for each project are:

Year Project ABUWA (₦) Project BRIWA (₦)
0 (800,000) (800,000)
1 200,000 600,000
2 360,000 240,000
3 360,000 20,000
4 170,000 –

The company has a policy that the maximum permissible payback period for an investment is three years and if a choice has to be made between the two projects, the project with the earlier payback will be chosen.

a. Calculate the payback period for each project:
i. Assuming that cash flows occur at year-end
ii. Assuming that cash flows after Year 0 occur at a constant rate throughout each year (16 Marks)

b. Which project should be selected according to the company’s payback rule? (2 Marks)

c. State the reasons for your decision in (b) above. (2 Marks)

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  • 1 Marks

BMF – May 2023 – L1 – SA – Q9 – Investment Decisions

Calculate the NPV of a project with given cash inflows over a 3-year period and a 10% cost of capital.

A firm plans to invest N20 million in a project with a life span of 3 years.

Projected cash inflows are as follows:

Years Cash Flows (N Million)
1 8
2 10
3 8

If the cost of capital is 10%, calculate the NPV of the project.

A. N1.34 million
B. N1.44 million
C. N1.54 million
D. N1.64 million
E. N1.74 million

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  • 10 Marks

BMF – May 2017 – L1 – SB – Q6b – Investment Decisions

Lists five advantages and disadvantages each of using IRR in capital investment appraisal.

State FIVE advantages and disadvantages each of Internal Rate of Return (IRR) as a method used in appraising capital investments.

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  • 10 Marks

BMF – May 2017 – L1 – SB – Q6 – Investment Decisions

Calculation of ARR for a machine investment and evaluation of the advantages and disadvantages of IRR.

Baseline Limited plans to buy a machine costing N500 million which will last for four years and then be sold for N5 million. Additional working capital in the sum of N5 million will be required as soon as the project starts. Net cash flow before tax is expected to be as follows:

Period Net Cash Flow (N millions)
Period 1 244
Period 2 286
Period 3 374
Period 4 156

Baseline Limited has a targeted Return on Capital Employed of 20%. Depreciation is charged on a straight-line basis over the life of an asset.

Required:

What is the Accounting Rate of Return (ARR) of this machine?

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  • 5 Marks

BMF – May 2024 – L1 – SB – Q3b – Investment Decisions

Explaining the steps in investment appraisal within capital budget and strategic planning.

b. Within the framework of a capital budget and strategic planning, state the FIVE steps of investment appraisal. (5 Marks)

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  • 15 Marks

MA – Mar 2023 – L2 – Q4a – Discounted cash flow

Determine whether Arkoo Ltd's project is viable using the NPV method.

Question:
Arkoo Ltd (Arkoo) is planning to invest GH¢5 million in its sound engineering studio with a life span of 10 years. Arkoo charges GH¢5.50 for every compact disc (CD) produced with an associated cost of GH¢4.80. The company plans to produce 8,700,000 CDs each year. Arkoo evaluates all investment opportunities against a discount factor of 21%.

Required:
i) Determine whether the project is viable or not using the Net Present Value (NPV) method.
ii) Calculate the percentage by which the following conditioning factors of Arkoo must change
in order for NPV to be zero.

  • Selling price (3 marks)

    • Variable cost (3 marks)

  • Sales Volume (3 marks)
  • Initial investment (3 marks)

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  • 16 Marks

QT – May 2019 – L1 – Q2b – Mathematics of Business Finance

Calculate NPV and IRR for two machines and determine which machine yields a better return.

BonBone Company Ltd wants to make a decision on which of the two machines to purchase. Each will involve a GH¢10,000 investment. The expected net incremental cash flows are given by the table below:

Year Machine I (GH¢) Machine II (GH¢)
1 5,000.00 2,000.00
2 4,000.00 3,000.00
3 2,000.00 5,000.00
4 2,000.00 4,000.00

Required:

i) If the company’s cost of capital is 10%, calculate the Net Present Value (NPV) of Machine I and Machine II and determine which machine should be purchased for higher returns. (8 marks)

ii) If the initial investment for Machine I is changed to GH¢4,000 and Machine II is changed to GH¢2,000, calculate the Internal Rate of Return (IRR) for Machine I and Machine II. (6 marks)

iii) If the IRRs in (ii) above are to be used as the basis of selection, determine which machine should be purchased for higher returns. (2 marks)

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  • 4 Marks

QT – May 2019 – L1 – Q2a – Mathematics of Business Finance

Distinguish between IRR and NPV, and evaluate investment decisions using NPV and IRR.

Distinguish between Internal Rate of Return and Net Present Value. (4 marks)

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  • 12 Marks

AFM – Nov 2018 – L3 – Q2a – International investment and financing decisions

Evaluate an international mining investment opportunity in South Africa using NPV approach for financial feasibility.

Rock Minerals Ltd (Rock) is a minerals mining company based in Ghana. Rock is considering an investment opportunity in South Africa, which involves developing and operating a gold mine and later transferring the mine to the South African government.

Last year, the directors commissioned a special committee to assess investments and regulatory requirements relating to the project. Based on the committee’s report, the directors estimate that it will take two years to develop the mine. Development of the mine entails an immediate outlay of ZAR1.2 million in regulatory requirement expenditures, an investment of ZAR20 million in plants and equipment in the first year, and ZAR15 million for development expenditure in the second year. The directors also estimate that Rock will invest ZAR2 million in net working capital at the beginning of the third year. The investment in net working capital is expected to be increased to ZAR3 million at the beginning of the fifth year.

Commercial production and sales are expected to begin in the third year. Below are estimated operating cash flows before tax in the first three years of commercial production:

Year Revenue collections (ZAR’ millions) Variable operating costs (ZAR’ millions) Fixed operating costs (ZAR’ millions)
3 100 40 20
4 150 50 25
5 210 80 30

At the end of the fifth year, Rock will transfer ownership and control of the mine to the South African government for an after-tax consideration of ZAR100 million. The special committee also reports that the income tax rate for mining operations is 30%, and capital expenditure in relation to acquisition of property, plant, and equipment, and development expenditure qualifies for capital allowance at the rate of 20% per annum on a straight-line basis. Capital allowance is granted at the end of each year of commercial production. On repatriation of profit, the committee reports that the South African government does not restrict the repatriation of profit, and there are no profit repatriation taxes. Rock would repatriate cash returns as they become available.

Rock plans to finance this project using existing capital. Rock’s after-tax cost of capital is 25% in Ghana. The annual rate of inflation is expected to be 11% in Ghana and 5% in South Africa in the coming years. Currently, the rate of exchange between the Ghanaian cedi (GH¢) and the South African rand (ZAR) is GH¢0.3822 = ZAR1.

Required:
Evaluate the project on financial grounds using the net present value (NPV) approach and recommend whether the investment proposal should be accepted for implementation or not.
(12 marks)

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  • 20 Marks

AFM – May 2018 – L3 – Q2 – Discounted cash flow techniques | Valuation and the use of free cash flows

Evaluating investment options using NPV and IRR to advise a company on which projects should be undertaken.

The Board of Peartek Ltd is considering the company’s capital investment options for the coming year, and is evaluating the following potential investments:

Investment A:

  • Investment of GH¢60,000, including GH¢40,000 for capital equipment and GH¢20,000 for increases in working capital.
  • Expected sales of 10,000 units next year with a sales price of GH¢10 and variable costs of GH¢6 per unit.
  • Sales price is expected to decline by 20% per annum due to competition, sales volume to fall by 10%, and variable costs to decline by 20%.
  • Overheads of GH¢15,000 annually, including a GH¢4,000 depreciation charge.
  • The project will be wound up in year three, with working capital recovered and capital equipment sold off for 25% of its cost.

Investment B:

  • Immediate outlay of GH¢90,000, financed by borrowing at 6%.
  • Expected net profits of GH¢12,000 next year, rising by 3% per annum indefinitely.

Investment C:

  • Outlay of GH¢25,000 financed by retained profits.
  • Expected annual net cash profits:
    • Years 1 to 4: GH¢3,000
    • Years 5 to 7: GH¢5,000
    • From year 8 onwards: GH¢7,000 in perpetuity.

The company discounts projects lasting 10 years or less at 10%, and others at 13%. Ignore taxation.

Required:

a) As a financial management analyst, you have been asked to advise the board of Peartek Ltd (in the form of a briefing report) which investment should be undertaken. Use the NPV method in your analysis. (15 marks)

b) Minority of board members feel that the Internal Rate of Return (IRR) should also be used as either an alternative or a complementary method of investment appraisal. Calculate the IRR of investments A and B and comment accordingly. (5 marks)

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