Question Tag: NPV Calculation

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  • 20 Marks

FM – May 2022 – L3 – Q3 – Investment Appraisal Techniques

Calculate NPV of an investment, discuss inflation's impact, and recommend an optimal project under capital constraints.

Opeyemi operates in an economy that has almost zero inflation. Management ignores inflation when evaluating investment projects because it is very low and considered insignificant. Opeyemi is evaluating a number of similar, alternative investments. The company uses an after-tax cost of capital of 6% and has already completed the evaluation of two investments.

The third investment is a new product that would be produced on a just-in-time basis and is expected to have a life of three years. This investment requires an immediate cash outflow of N200,000, which does not qualify for tax depreciation. The expected residual value at the end of the project’s life is N50,000.

A draft financial statement showing the values that are specific to this investment for the three years is as follows:

Year 1 2 3
Sales 230,000 350,000 270,000
Production Costs:
Materials 54,000 102,000 66,000
Labour 60,000 80,000 70,000
Other* 80,000 90,000 80,000
Profit 36,000 78,000 54,000
Closing Receivables 20,000 30,000 25,000
Closing Payables 6,000 9,000 8,000

*Other production costs shown above include depreciation calculated using the straight-line method.

The company is liable to pay corporate tax at a rate of 30% of its profits. One half of this is payable in the same year as the profit is earned, and the remainder is payable in the following year.

Required:

a. Calculate the net present value of the above investment proposal. (14 Marks)

b. Explain how the above investment project would be appraised if there were to be a change in the rate of inflation, so that it became too significant to be ignored. (3 Marks)

c. The evaluation of the other two investments is shown below:

Investment Initial Investment Net Present Value
W 300,000 75,000
Y 100,000 27,000

The company only has N400,000 of funds available. All of the investment proposals are non-divisible. None of the investments may be repeated.

Required:

Recommend, with supporting calculations, which of the three investment proposals should be accepted. (3 Marks)

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  • 30 Marks

FM – Nov 2020 – L3 – Q1 – International Financial Management

Evaluates a foreign investment project in Linder, with NPV, payback period, and real options for abandonment analyzed under two scenarios.

Assume today is November 20, 2019. In 2018, the Oyin Division of Aba plc successfully launched a new premium wine, “Aladun,” in Nigeria. The Divisional Board of Oyin Division is now considering plans put forward by the Divisional Marketing Manager to launch the full range of Aladun in another country, “Linder.” Linder has the Linderian dollar (L$) as its currency, and the launch is planned for January 1, 2020.

It is known that breaking into the Linderian market for fruit wine is challenging due to strong local brand loyalty. Initial market research based on free tasting sessions has been promising, though uncertainties remain. The biggest risk identified is the potential for a Nigerian competitor to enter the same market with a similar product.

Financial Data for the Project:

  • Initial market research for the Linderian market: N5 million (already spent).
  • Additional detailed market research and packaging design (if approved): N20 million.
  • Launch campaign (radio and TV advertising): N10 million.
  • Distribution center in Linder: L$84 million.

Operating cash flow forecasts for the year ending December 31, 2020, vary based on two scenarios:

  • Scenario A: Sales revenue L$100 million; costs L$10 million + N20 million.
  • Scenario B: Sales revenue L$55 million; costs L$10 million + N15 million.
  • Probability of occurrence: 70% for Scenario A, 30% for Scenario B.

Other relevant financial data:

  • Oyin Division’s project evaluation discount rate: 15%.
  • Project duration: 4 years.
  • Expected operating cash flow growth: 5% per year.
  • Residual value of the distribution center: L$52 million after 4 years.
  • Exchange rate: N1 = L$1.2000 on January 1, 2020 (strengthening by 2% per year).
  • Corporate tax rate in Nigeria: 35%.
  • Tax allowances on capital expenditure: 100% (tax-deductible in Nigeria).

Additional Option:

  • The project could be abandoned on January 1, 2021, with the distribution center sold for an estimated L$70 million if Scenario B occurs.

Required:

a. Ignoring the abandonment option: i. Calculate the NPV for the project as of January 1, 2020, for each scenario and the overall total expected NPV. (17 Marks) ii. Calculate the payback period for each scenario. (4 Marks) iii. Interpret your results. (4 Marks)

b. Evaluate the abandonment decision on January 1, 2021, if Scenario B occurs. (7 Marks)

c. Advise on how real options and other strategic financial issues may influence the investment decision. (8 Marks)

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  • 10 Marks

MA – May 2017 – L2 – Q1a – Introduction to capital budgeting,

Calculate the break-even rate for a taxi service investment considering a 5% annual cash flow increase over five years.

Kwame, after his National Service and with no hope of securing a job in the formal sector, has decided to run a taxi service. The following forecast has been made for the operation of a service between Abisim and Sunyani:

  1. Revenue totaling GH¢300 a week for 52 weeks in a year. This is net of fuel and other variable costs.
  2. Tyres: four pieces for a year at GH¢120 per unit.
  3. Maintenance and servicing: GH¢120 per month.
  4. Salaries: GH¢3,000 per year.
  5. Insurance: GH¢350 per year.

The net cash flow will increase at 5% per annum for the next five years due to inflation. The cost of the vehicle is estimated at GH¢28,000. The project appears quite profitable based on the NPV criteria using the Government policy rate of 26%. However, the banks are offering rates far higher than the policy rate.

Required:

You are to calculate the break-even rate for the project.

(10 marks)

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  • 20 Marks

FM – DEC 2023 – L2 – Q4 – Capital rationing | Introduction to Investment Appraisal | Sources of finance: debt

Explanation of capital rationing concepts, NPV and profitability index calculations, and factors influencing debt finance decisions.

a) In periods of difficult global financial environment, raising of capital is a challenge necessitating the need for prudent and best use of scarce capital for projects.

Required:
i) Explain the term capital rationing. (2 marks)
ii) Distinguish between soft capital rationing and hard capital rationing giving an example each. (3 marks)

b) Akonta Ghana Ltd has excess funds of GH¢200 million and is looking for attractive investment opportunities that will yield a return of 15% per annum or better to deploy the funds. An extract from a Feasibility report submitted by a team of investment and project experts is as follows:

Project Initial Investment Required (GH¢) Constant Annual Cash Inflow (GH¢) Project Life (Years)
A 80,000,000 36,000,000 4
B 40,000,000 23,000,000 3
C 78,000,000 30,000,000 5
D 40,000,000 20,000,000 4
E 40,000,000 22,000,000 3

The cash flows per project are constant for the life span of each project and each project is divisible for the purpose of capital allocation.

Required:
i) Calculate the Net Present Values (NPVs) of each project. (7 marks)
ii) Rank the projects using Profitability Index and allocate the GH¢200 million among the projects. (3 marks)

c) There are many sources of debt finance available to a company which has viable and profitable investment opportunities to utilise the funds. It is, however, very important for the Finance Manager to do a thorough work before deciding the type and source of debt finance to tap into.

Required:
Explain THREE (3) factors a Finance Manager should consider when deciding the type of debt finance to raise. (5 marks)

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  • 20 Marks

FM – AUG 2022 – L2 – Q4 – Capital structure

Evaluates the decision between leasing and buying, calculates NPV, and explains the benefits of listing on the stock market.

a) Lease or Buy decision could be a tough call to make, especially considering that different industries benefit more than others from leasing or buying outright depending on the specific needs of that sector.

Freda Automobile (Freda), an emerging automobile company has taken a decision to provide a new Toyota Land Cruiser for its Chief Executive Officer (CEO). The company is considering whether to buy or lease. The Toyota Land Cruiser has a useful life of six years and will cost GH¢1,000,000 to buy and will be funded with a bank loan. The Finance Director provided the borrowing interest rate for the loan at 22% per annum. The annual repairs and maintenance cost when the V8 is bought is GH¢18,000. The corporate tax rate is currently 25% paid in the same year the profit is made. The capital allowance on the V8 is 25% per annum on reducing balance basis.

Alternatively, the Toyota Land Cruiser could be leased at a rental cost of GH¢250,000 per annum for six years payable at the beginning of each year.

Required:
i) Explain TWO (2) reasons why Freda will prefer leasing option to outright buy. (4 marks)
ii) Calculate the Net Present Value (NPV) for the buy option. (5 marks)
iii) Calculate the Net Present Value (NPV) for the lease option. (4 marks)
iv) Based on your computations in ii) and iii) above, advise management which option should be considered. (2 marks)

b) The Ghana Stock Exchange (GSE) market has recently been intensifying its public education for Ghanaian companies to list on the stock market to raise the needed capital for expansion and growth. You have been approached by owners of Asafo Ghana Ltd who have expressed interest in getting listed on the stock market but have limited knowledge on what they stand to benefit by listing their company on the market.

Required:
Explain FOUR (4) advantages Asafo Ghana Ltd could derive from listing on GSE. (5 marks)

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  • 20 Marks

FM – MAR 2024 – L2 – Q4 – Introduction to investment appraisal

This question involves calculating the NPV of a project, advising on whether to undertake the project, and explaining why NPV is preferred over the payback period as an investment appraisal method.

a) Toolo Ghana Ltd was recently formed as a special purpose vehicle (SPV) to provide a secondary market for investors involved in the domestic debt exchange programme who want to sell off their holdings for immediate cash.

The SPV was embarking on this special initiative as a one-off project; The company in year zero will acquire a total of GH¢500 million worth of bonds from investors and pay for all at the same time for cash.

Based on the projections, the expected cash inflows from the bonds are as follows:

  • Year 1 = GH¢100 million
  • Year 2 = Year 1 cash flows + 20% increase
  • Year 3 = Year 2 cash flows + 15% increase
  • Year 4 = Year 3 cash flows + 25% increase
  • Year 5 = Year 4 cash flows + 20% increase

A special investment in systems and software, computers and other fixed assets is GH¢6 million in year zero and tax deductible depreciation is on a straight-line basis with a scrap value of GH¢1 million. Salaries and wages and other administrative expenses will be GH¢1 million in year 1 and grow at 15% per annum on the previous year’s figure. Rent is also determined at GH¢0.5 million in year 1 and growing by GH¢100,000 each year.

The internal cost of capital is 22% whilst corporate tax rate is 25%.

Required:

i) Calculate the Net Present Value (NPV) of this project and advise whether Toolo Ltd should embark on the project.
(12 marks)

ii) Explain TWO (2) reasons why NPV is preferred to payback period.
(3 marks)

b) Soso Ghana Ltd is considering investing in project Sankofa which has been appraised to have an expected return of 25% per annum. The project’s beta is 1.9 and the risk-free interest rate is 14% per annum, which is 9% below the average return on equity stocks on the market.

Required:

Calculate the required return on project Sankofa and advise Soso Ghana Ltd whether it should invest in the project.
(5 marks)

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  • 10 Marks

FM – NOV 2015 – L2 – Q3b – Introduction to financial management

Calculate the NPV for God is King Ltd's project and advise management on whether to accept or reject the project.

God is King Ltd has been printing all its magazines from Dubai due to the comparative cost advantage. The company is considering establishing its own printing department, and the R&D team has identified a printing machine which will meet the quality and cost specifications of God is King Ltd. The machine also has the capacity to print to meet the market needs of the company. The machine, which has a useful life of 5 years, will cost GHS800,000 and immediate installation cost will be GHS50,000. Fixed cost for maintaining the machine will be 170,000 per annum over the machine’s useful life and additional working capital of GHS30,000 will be introduced in year 2. The use of this machine will generate a contribution of GHS500,000 per annum for five (5) years. Corporate income tax rate, payable in arrears, is 25% and the company’s after-tax cost of capital is 20%. No capital allowance is permitted.

Required:
Calculate the NPV for the project and advise management on whether to accept or reject the project. (10 marks)

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  • 20 Marks

FM – May 2022 – L3 – Q3 – Investment Appraisal Techniques

Calculate NPV of an investment, discuss inflation's impact, and recommend an optimal project under capital constraints.

Opeyemi operates in an economy that has almost zero inflation. Management ignores inflation when evaluating investment projects because it is very low and considered insignificant. Opeyemi is evaluating a number of similar, alternative investments. The company uses an after-tax cost of capital of 6% and has already completed the evaluation of two investments.

The third investment is a new product that would be produced on a just-in-time basis and is expected to have a life of three years. This investment requires an immediate cash outflow of N200,000, which does not qualify for tax depreciation. The expected residual value at the end of the project’s life is N50,000.

A draft financial statement showing the values that are specific to this investment for the three years is as follows:

Year 1 2 3
Sales 230,000 350,000 270,000
Production Costs:
Materials 54,000 102,000 66,000
Labour 60,000 80,000 70,000
Other* 80,000 90,000 80,000
Profit 36,000 78,000 54,000
Closing Receivables 20,000 30,000 25,000
Closing Payables 6,000 9,000 8,000

*Other production costs shown above include depreciation calculated using the straight-line method.

The company is liable to pay corporate tax at a rate of 30% of its profits. One half of this is payable in the same year as the profit is earned, and the remainder is payable in the following year.

Required:

a. Calculate the net present value of the above investment proposal. (14 Marks)

b. Explain how the above investment project would be appraised if there were to be a change in the rate of inflation, so that it became too significant to be ignored. (3 Marks)

c. The evaluation of the other two investments is shown below:

Investment Initial Investment Net Present Value
W 300,000 75,000
Y 100,000 27,000

The company only has N400,000 of funds available. All of the investment proposals are non-divisible. None of the investments may be repeated.

Required:

Recommend, with supporting calculations, which of the three investment proposals should be accepted. (3 Marks)

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  • 30 Marks

FM – Nov 2020 – L3 – Q1 – International Financial Management

Evaluates a foreign investment project in Linder, with NPV, payback period, and real options for abandonment analyzed under two scenarios.

Assume today is November 20, 2019. In 2018, the Oyin Division of Aba plc successfully launched a new premium wine, “Aladun,” in Nigeria. The Divisional Board of Oyin Division is now considering plans put forward by the Divisional Marketing Manager to launch the full range of Aladun in another country, “Linder.” Linder has the Linderian dollar (L$) as its currency, and the launch is planned for January 1, 2020.

It is known that breaking into the Linderian market for fruit wine is challenging due to strong local brand loyalty. Initial market research based on free tasting sessions has been promising, though uncertainties remain. The biggest risk identified is the potential for a Nigerian competitor to enter the same market with a similar product.

Financial Data for the Project:

  • Initial market research for the Linderian market: N5 million (already spent).
  • Additional detailed market research and packaging design (if approved): N20 million.
  • Launch campaign (radio and TV advertising): N10 million.
  • Distribution center in Linder: L$84 million.

Operating cash flow forecasts for the year ending December 31, 2020, vary based on two scenarios:

  • Scenario A: Sales revenue L$100 million; costs L$10 million + N20 million.
  • Scenario B: Sales revenue L$55 million; costs L$10 million + N15 million.
  • Probability of occurrence: 70% for Scenario A, 30% for Scenario B.

Other relevant financial data:

  • Oyin Division’s project evaluation discount rate: 15%.
  • Project duration: 4 years.
  • Expected operating cash flow growth: 5% per year.
  • Residual value of the distribution center: L$52 million after 4 years.
  • Exchange rate: N1 = L$1.2000 on January 1, 2020 (strengthening by 2% per year).
  • Corporate tax rate in Nigeria: 35%.
  • Tax allowances on capital expenditure: 100% (tax-deductible in Nigeria).

Additional Option:

  • The project could be abandoned on January 1, 2021, with the distribution center sold for an estimated L$70 million if Scenario B occurs.

Required:

a. Ignoring the abandonment option: i. Calculate the NPV for the project as of January 1, 2020, for each scenario and the overall total expected NPV. (17 Marks) ii. Calculate the payback period for each scenario. (4 Marks) iii. Interpret your results. (4 Marks)

b. Evaluate the abandonment decision on January 1, 2021, if Scenario B occurs. (7 Marks)

c. Advise on how real options and other strategic financial issues may influence the investment decision. (8 Marks)

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  • 10 Marks

MA – May 2017 – L2 – Q1a – Introduction to capital budgeting,

Calculate the break-even rate for a taxi service investment considering a 5% annual cash flow increase over five years.

Kwame, after his National Service and with no hope of securing a job in the formal sector, has decided to run a taxi service. The following forecast has been made for the operation of a service between Abisim and Sunyani:

  1. Revenue totaling GH¢300 a week for 52 weeks in a year. This is net of fuel and other variable costs.
  2. Tyres: four pieces for a year at GH¢120 per unit.
  3. Maintenance and servicing: GH¢120 per month.
  4. Salaries: GH¢3,000 per year.
  5. Insurance: GH¢350 per year.

The net cash flow will increase at 5% per annum for the next five years due to inflation. The cost of the vehicle is estimated at GH¢28,000. The project appears quite profitable based on the NPV criteria using the Government policy rate of 26%. However, the banks are offering rates far higher than the policy rate.

Required:

You are to calculate the break-even rate for the project.

(10 marks)

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  • 20 Marks

FM – DEC 2023 – L2 – Q4 – Capital rationing | Introduction to Investment Appraisal | Sources of finance: debt

Explanation of capital rationing concepts, NPV and profitability index calculations, and factors influencing debt finance decisions.

a) In periods of difficult global financial environment, raising of capital is a challenge necessitating the need for prudent and best use of scarce capital for projects.

Required:
i) Explain the term capital rationing. (2 marks)
ii) Distinguish between soft capital rationing and hard capital rationing giving an example each. (3 marks)

b) Akonta Ghana Ltd has excess funds of GH¢200 million and is looking for attractive investment opportunities that will yield a return of 15% per annum or better to deploy the funds. An extract from a Feasibility report submitted by a team of investment and project experts is as follows:

Project Initial Investment Required (GH¢) Constant Annual Cash Inflow (GH¢) Project Life (Years)
A 80,000,000 36,000,000 4
B 40,000,000 23,000,000 3
C 78,000,000 30,000,000 5
D 40,000,000 20,000,000 4
E 40,000,000 22,000,000 3

The cash flows per project are constant for the life span of each project and each project is divisible for the purpose of capital allocation.

Required:
i) Calculate the Net Present Values (NPVs) of each project. (7 marks)
ii) Rank the projects using Profitability Index and allocate the GH¢200 million among the projects. (3 marks)

c) There are many sources of debt finance available to a company which has viable and profitable investment opportunities to utilise the funds. It is, however, very important for the Finance Manager to do a thorough work before deciding the type and source of debt finance to tap into.

Required:
Explain THREE (3) factors a Finance Manager should consider when deciding the type of debt finance to raise. (5 marks)

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  • 20 Marks

FM – AUG 2022 – L2 – Q4 – Capital structure

Evaluates the decision between leasing and buying, calculates NPV, and explains the benefits of listing on the stock market.

a) Lease or Buy decision could be a tough call to make, especially considering that different industries benefit more than others from leasing or buying outright depending on the specific needs of that sector.

Freda Automobile (Freda), an emerging automobile company has taken a decision to provide a new Toyota Land Cruiser for its Chief Executive Officer (CEO). The company is considering whether to buy or lease. The Toyota Land Cruiser has a useful life of six years and will cost GH¢1,000,000 to buy and will be funded with a bank loan. The Finance Director provided the borrowing interest rate for the loan at 22% per annum. The annual repairs and maintenance cost when the V8 is bought is GH¢18,000. The corporate tax rate is currently 25% paid in the same year the profit is made. The capital allowance on the V8 is 25% per annum on reducing balance basis.

Alternatively, the Toyota Land Cruiser could be leased at a rental cost of GH¢250,000 per annum for six years payable at the beginning of each year.

Required:
i) Explain TWO (2) reasons why Freda will prefer leasing option to outright buy. (4 marks)
ii) Calculate the Net Present Value (NPV) for the buy option. (5 marks)
iii) Calculate the Net Present Value (NPV) for the lease option. (4 marks)
iv) Based on your computations in ii) and iii) above, advise management which option should be considered. (2 marks)

b) The Ghana Stock Exchange (GSE) market has recently been intensifying its public education for Ghanaian companies to list on the stock market to raise the needed capital for expansion and growth. You have been approached by owners of Asafo Ghana Ltd who have expressed interest in getting listed on the stock market but have limited knowledge on what they stand to benefit by listing their company on the market.

Required:
Explain FOUR (4) advantages Asafo Ghana Ltd could derive from listing on GSE. (5 marks)

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  • 20 Marks

FM – MAR 2024 – L2 – Q4 – Introduction to investment appraisal

This question involves calculating the NPV of a project, advising on whether to undertake the project, and explaining why NPV is preferred over the payback period as an investment appraisal method.

a) Toolo Ghana Ltd was recently formed as a special purpose vehicle (SPV) to provide a secondary market for investors involved in the domestic debt exchange programme who want to sell off their holdings for immediate cash.

The SPV was embarking on this special initiative as a one-off project; The company in year zero will acquire a total of GH¢500 million worth of bonds from investors and pay for all at the same time for cash.

Based on the projections, the expected cash inflows from the bonds are as follows:

  • Year 1 = GH¢100 million
  • Year 2 = Year 1 cash flows + 20% increase
  • Year 3 = Year 2 cash flows + 15% increase
  • Year 4 = Year 3 cash flows + 25% increase
  • Year 5 = Year 4 cash flows + 20% increase

A special investment in systems and software, computers and other fixed assets is GH¢6 million in year zero and tax deductible depreciation is on a straight-line basis with a scrap value of GH¢1 million. Salaries and wages and other administrative expenses will be GH¢1 million in year 1 and grow at 15% per annum on the previous year’s figure. Rent is also determined at GH¢0.5 million in year 1 and growing by GH¢100,000 each year.

The internal cost of capital is 22% whilst corporate tax rate is 25%.

Required:

i) Calculate the Net Present Value (NPV) of this project and advise whether Toolo Ltd should embark on the project.
(12 marks)

ii) Explain TWO (2) reasons why NPV is preferred to payback period.
(3 marks)

b) Soso Ghana Ltd is considering investing in project Sankofa which has been appraised to have an expected return of 25% per annum. The project’s beta is 1.9 and the risk-free interest rate is 14% per annum, which is 9% below the average return on equity stocks on the market.

Required:

Calculate the required return on project Sankofa and advise Soso Ghana Ltd whether it should invest in the project.
(5 marks)

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  • 10 Marks

FM – NOV 2015 – L2 – Q3b – Introduction to financial management

Calculate the NPV for God is King Ltd's project and advise management on whether to accept or reject the project.

God is King Ltd has been printing all its magazines from Dubai due to the comparative cost advantage. The company is considering establishing its own printing department, and the R&D team has identified a printing machine which will meet the quality and cost specifications of God is King Ltd. The machine also has the capacity to print to meet the market needs of the company. The machine, which has a useful life of 5 years, will cost GHS800,000 and immediate installation cost will be GHS50,000. Fixed cost for maintaining the machine will be 170,000 per annum over the machine’s useful life and additional working capital of GHS30,000 will be introduced in year 2. The use of this machine will generate a contribution of GHS500,000 per annum for five (5) years. Corporate income tax rate, payable in arrears, is 25% and the company’s after-tax cost of capital is 20%. No capital allowance is permitted.

Required:
Calculate the NPV for the project and advise management on whether to accept or reject the project. (10 marks)

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