- 20 Marks
FM – L2 – Q76 – Investment Appraisal
Question
(A) Describe FOUR (4) ways in which the investment appraisal approach of a City Council will differ from a GoldPeak Ltd, a mining company.
(B) StarPrint Ltd has been printing all its magazines from a facility in Abu Dhabi due to cost advantages. The company is considering establishing its own printing department, and the R&D team has identified a printing machine that meets the quality and cost specifications of StarPrint 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 GH₵800,000, and immediate installation cost will be GH₵50,000. Fixed cost for maintaining the machine will be GH₵170,000 per annum over the machine’s useful life, and additional working capital of GH₵30,000 will be introduced in year 2. The use of this machine will generate a contribution of GH₵500,000 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.
(C) Explain the following types of contracts:
(i) Mudaraba contract
(ii) Musharaka contract
(iii) Murabaha contract
Answer
(A)
- When choosing between mutually exclusive projects, GoldPeak Ltd will prefer a project with the highest NPV. However, a City Council will prioritize the highest social benefit over financial benefit.
- A City Council will rely on an interest rate determined by central government or a government borrowing rate, whereas GoldPeak Ltd will use a market-determined cost of capital, such as the weighted average cost of capital (WACC).
- A City Council will incorporate non-financial criteria, such as social and environmental impacts, into its decision-making process, while GoldPeak Ltd will focus primarily on financial returns.
- GoldPeak Ltd will aim to maximize shareholder wealth, whereas a City Council will focus on maximizing benefits to the community, such as improving infrastructure or public services.
(B).
| Year | 0 | 1 | 2 | 3 | 4 | 5 | 6 |
|---|---|---|---|---|---|---|---|
| Contribution | 500,000 | 500,000 | 500,000 | 500,000 | 500,000 | ||
| Fixed cost | (170,000) | (170,000) | (170,000) | (170,000) | (170,000) | ||
| Taxable cash flow | 330,000 | 330,000 | 330,000 | 330,000 | 330,000 | ||
| Tax (25%) | (82,500) | (82,500) | (82,500) | (82,500) | (82,500) | ||
| Machine cost | (800,000) | ||||||
| Installation | (50,000) | ||||||
| Working capital | (30,000) | 30,000 | |||||
| Net cash flow | (850,000) | 330,000 | 217,500 | 247,500 | 247,500 | 247,500 | (52,500) |
| DF (20%) | 1.000 | 0.833 | 0.694 | 0.579 | 0.482 | 0.402 | 0.335 |
| PV | (850,000) | 274,890 | 150,915 | 143,303 | 119,295 | 99,495 | (17,588) |
NPV = -850,000 + 274,890 + 150,915 + 143,303 + 119,295 + 99,495 – 17,588 = -79,690
The NPV is negative at GH₵-79,690, indicating that the project will reduce the company’s value. Therefore, management should reject the project.
(C).
(i) Mudaraba Contract: This is a partnership where one party provides capital (the investor or rabb-ul-mal) and the other provides expertise and management (the entrepreneur or mudarib). Profits are shared according to a pre-agreed ratio, but losses are borne solely by the capital provider unless negligence is proven.
(ii) Musharaka Contract: This is a joint venture where all partners contribute capital and share profits and losses in proportion to their investment. All partners have management rights, though roles can be delegated. It is commonly used for business ventures or property financing.
(iii) Murabaha Contract: This is a cost-plus financing contract where the seller discloses the cost of a commodity and adds an agreed profit margin. The buyer pays in installments or a lump sum, often used for asset purchases like vehicles or equipment, ensuring transparency in pricing.
- Topic: Islamic Finance
- Uploader: Samuel Duah