Question Tag: Profitability Index

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  • 15 Marks

PSAF – May 2024 – L2 – SB – Q6 – Government Expenditure

Evaluation of investment projects using Profitability Index.

a. Oyigbo Local Government is set to improve its internally generated revenue by venturing into the construction of an animal feedmill, which will cost N15 million. The mill, when constructed, is projected to generate a net cash inflow of N3.8 million annually and the useful life is 6 years. The cost of borrowing from a commercial bank for this purpose is 12%.

Required:
Advise the Chairman of Oyigbo Local Government whether or not to undertake the project using the Profitability Index (PI) technique of investment appraisal.

The cumulative discount factor formula to use is:

where  discount rate,  number of years. (10 Marks)

b. Identify THREE advantages and TWO disadvantages of the profitability index as a technique for project appraisal. (5 Marks)

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  • 15 Marks

PSAF – Nov 2021 – L2 – Q7 – Government Accounting Concepts and Principles

Calculate NPV for projects, profitability index, and discuss ranking differences.

Otunba Local Government wishes to boost its revenue generation and six possible capital investments have been identified. However, the Local Government only has access to a total of N6,200,000. The projects may not be postponed until a future period, and it is unlikely that similar investment opportunities will occur.

Expected net cash flows are:

Projects A and E are mutually exclusive while all the projects are believed to be of similar risk to the Local Government’s existing capital investments. Any surplus funds may be invested in the money market to earn a return of 9% per year. The money market may be assumed to be an efficient market. The Local Government’s cost of capital is 12% per year.

Required:

(a) Calculate the expected net present value for each project, and rank the projects. (8 Marks)
(b) Assuming the projects are divisible, calculate the Profitability Index for each project and rank the projects to determine how the money would be best invested. (6 Marks)
(c) State why the rankings in (b) differ from that in (a) above. (1 Mark)

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  • 20 Marks

SCS – Apr 2022 – L3 – Q6 – Investment decisions

Compute NPV for two investment options and evaluate potential benefits and difficulties for HPC.

a) For the two strategic development options being considered by HPC, compute:
i) the Net Present Value of Option 1.
ii) the Net Present Value of Option 2.
iii) the Net Present Value for the worst-case outcome for Option 1. (10 marks)

b) Discuss THREE (3) potential benefits and TWO (2) difficulties for HPC of undertaking each of the strategic development options. Your answer should include an evaluation of the calculations of the profitability index of each option. (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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  • 15 Marks

FM – Nov 2017 – L2 – Q3b – Capital rationing

Determine which projects should be selected based on the capital budget and profitability index under given constraints.

The Gomoa Chemical Limited has a capital budget for 2018 of GH¢1,000,000. The following capital investment proposals are submitted to the capital budget committee:

PROJECT PROFITABILITY INDEX OUTLAY
1 1.2 200,000
2 1.18 200,000
3 1.17 100,000
4 1.10 300,000
5 1.15 200,000
6 1.13 200,000
7 1.19 400,000
8 1.21 100,000
9 1.22 100,000
10 1.16 100,000

The company’s cost of capital is 5%. Projects 2 and 8 are mutually exclusive: Projects 1 and 5 are mutually dependent.

Required:
As the chairman of the budget committee, which projects should the committee choose? (15 marks)

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  • 15 Marks

PSAF – May 2024 – L2 – SB – Q6 – Government Expenditure

Evaluation of investment projects using Profitability Index.

a. Oyigbo Local Government is set to improve its internally generated revenue by venturing into the construction of an animal feedmill, which will cost N15 million. The mill, when constructed, is projected to generate a net cash inflow of N3.8 million annually and the useful life is 6 years. The cost of borrowing from a commercial bank for this purpose is 12%.

Required:
Advise the Chairman of Oyigbo Local Government whether or not to undertake the project using the Profitability Index (PI) technique of investment appraisal.

The cumulative discount factor formula to use is:

where  discount rate,  number of years. (10 Marks)

b. Identify THREE advantages and TWO disadvantages of the profitability index as a technique for project appraisal. (5 Marks)

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  • 15 Marks

PSAF – Nov 2021 – L2 – Q7 – Government Accounting Concepts and Principles

Calculate NPV for projects, profitability index, and discuss ranking differences.

Otunba Local Government wishes to boost its revenue generation and six possible capital investments have been identified. However, the Local Government only has access to a total of N6,200,000. The projects may not be postponed until a future period, and it is unlikely that similar investment opportunities will occur.

Expected net cash flows are:

Projects A and E are mutually exclusive while all the projects are believed to be of similar risk to the Local Government’s existing capital investments. Any surplus funds may be invested in the money market to earn a return of 9% per year. The money market may be assumed to be an efficient market. The Local Government’s cost of capital is 12% per year.

Required:

(a) Calculate the expected net present value for each project, and rank the projects. (8 Marks)
(b) Assuming the projects are divisible, calculate the Profitability Index for each project and rank the projects to determine how the money would be best invested. (6 Marks)
(c) State why the rankings in (b) differ from that in (a) above. (1 Mark)

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  • 20 Marks

SCS – Apr 2022 – L3 – Q6 – Investment decisions

Compute NPV for two investment options and evaluate potential benefits and difficulties for HPC.

a) For the two strategic development options being considered by HPC, compute:
i) the Net Present Value of Option 1.
ii) the Net Present Value of Option 2.
iii) the Net Present Value for the worst-case outcome for Option 1. (10 marks)

b) Discuss THREE (3) potential benefits and TWO (2) difficulties for HPC of undertaking each of the strategic development options. Your answer should include an evaluation of the calculations of the profitability index of each option. (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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  • 15 Marks

FM – Nov 2017 – L2 – Q3b – Capital rationing

Determine which projects should be selected based on the capital budget and profitability index under given constraints.

The Gomoa Chemical Limited has a capital budget for 2018 of GH¢1,000,000. The following capital investment proposals are submitted to the capital budget committee:

PROJECT PROFITABILITY INDEX OUTLAY
1 1.2 200,000
2 1.18 200,000
3 1.17 100,000
4 1.10 300,000
5 1.15 200,000
6 1.13 200,000
7 1.19 400,000
8 1.21 100,000
9 1.22 100,000
10 1.16 100,000

The company’s cost of capital is 5%. Projects 2 and 8 are mutually exclusive: Projects 1 and 5 are mutually dependent.

Required:
As the chairman of the budget committee, which projects should the committee choose? (15 marks)

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