Capital Budgeting

FM – L2 – Q84 – Discounted cash flow

Calculate NPV and estimate IRR for a project with given cash flows and discount rates.

Question

A company is considering whether to invest in a new item of equipment costing GH₵45,000 to make a new product. The product would have a four-year life, and the estimated cash profits over the four-year period are as follows.

Year	GH₵
1	17,000
2	25,000
3	16,000
4	4,000

The project would also need an investment in working capital of GH₵8,000, from the beginning of Year 1.
The company uses a discount rate of 11% to evaluate its investments.
Required
Calculate the NPV of the project at the discount rate of 11%.
Using the NPV you have calculated at 11%, and the NPV at a discount rate of 15%, estimate the internal rate of return (IRR) of the project.

Answer

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Tags: Capital Budgeting, Discounted cash flow, investment appraisal, IRR, NPV
Level: Level 2

Topic: Discounted cash flow

FM – L2 – Q79 – Discounted Cash Flow

Calculate NPV for three investment projects with varying cash flows and discount rates for Zenith Solutions Ltd.

Question

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

Investment A
This investment is similar to its current investments and requires an investment of GH₵60,000 now, GH₵40,000 for new capital equipment and GH₵20,000 for increases in working capital. This will be financed from Shareholders Funds. Sales next year would be 10,000 units, variable costs would be GH₵6 and the product would be sold for GH₵10. But due to entry of new competitors and technological improvements, the sales price would decline by 20% per annum thereafter, sales volume would fall by 10% and variable costs would fall by 20% per annum. Overheads attributed to the project would be GH₵15,000 per annum.
In year three the project would be wound up, working capital investment would be recovered and capital equipment sold off for 25% of its purchase costs the following year. Fixed costs include an annual charge of GH₵4,000 for depreciation.

Investment B
This is a long-term project in a totally new area, involving an immediate outlay of GH₵90,000, which they intend to borrow from their lenders at 6%. They expect net profits of GH₵12,000 next year, rising thereafter by 3% per annum in perpetuity.

Investment C
This is another long-term investment in a totally new area, involving an immediate outlay of GH₵25,000 which they intend financing by retained earnings. Expected annual net cash profits are as follows:
Years 1 to 4: GH₵3,000
Years 5 to 7: GH₵5,000
Year 8 onwards forever: GH₵7,000
The company discounts all projects lasting ten years duration or less at a cost of capital of 10% and all other projects at a cost of 13%. You may ignore taxation.

Required:
(a) Calculate the NPV of each project.

(b) Calculate the IRR of investments A and B (you may use 25% as the upper limit if you wish) and comment accordingly.

Answer

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Tags: Capital Budgeting, Discounted cash flow, investment appraisal, IRR, Perpetuity
Level: Level 2

Topic: Discounted cash flow

FM – L2 – Q73 – Discounted Cash Flow

Calculate the breakeven rate of return for Kofi's taxi service project using NPV criteria with given cash flows and costs.

Question

Kofi, 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 have been made for the operation of a service between Asikrom and Sunyasi:
(i) Revenue totalling GH¢300 a week for 52 weeks in a year. This is net of fuel and other variable costs.
(ii) Tyres; four pieces for a year at GH¢120 per unit.
(iii) Maintenance and servicing; GH¢120 per month.
(iv) Salaries GH¢3,000 per year.
(v) 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:
Calculate the breakeven rate of return for the project.

Answer

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Tags: Capital Budgeting, Cash Flow Analysis, Discounted cash flow, Internal Rate of Return, Net Present Value
Level: Level 2

Topic: Discounted cash flow

FM – L2 – Q72 – Discounted cash flow

Calculate NPV for two machines with given cash flows, tax, and capital allowances.

Question

72 NANTWI PLC
The directors of Nantwi Plc are meeting to decide about the replacement of a machine. The existing machine has to be replaced soon, and there is a choice of two machines that could be purchased to replace it. These are Machine A and a larger Machine, B. The following information is available about each machine:

	Machine A	Machine B
Expected working life	4 years	5 years
Initial cost	GH₵600,000	GH₵750,000
Residual value	GH₵0	GH₵0
Working capital requirement	GH₵100,000	GH₵200,000

The forecast pre-tax cash flows that will be earned using each machine are as follows:

	Year 1	Year 2	Year 3	Year 4	Year 5
	GH₵000	GH₵000	GH₵000	GH₵000	GH₵000
Machine A	470	520	490	450
Machine B	580	640	500	500	400

Nantwi Plc uses 10% as its cost of capital for capital expenditure evaluation.
Taxation at 30% is payable one year in arrears. Capital allowances are available at the rate of 25% each year on the reducing balance method. Inflation should be ignored.

Required
(a) Calculate the NPV with each of the machines.

(b) Calculate the payback period for each machine.

Answer

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Tags: Capital Budgeting, Investment decision, Machine Replacement, NPV
Level: Level 2

Topic: Capital budgeting

FM – L2 – Q52 – Discounted cash flow

Calculate NPV and IRR for two mutually exclusive projects for Dambai Energy Ltd.

Question

Dambai Energy Ltd is considering whether to invest in either of two mutually-exclusive projects, Project 1 and Project 2. Both projects involve the purchase of machinery with a life of five years.
Project 1: The machine would cost GH₵556,000 and would have a net disposal value of GH₵56,000 at the end of Year 5. The project would earn annual cash flows (receipts minus payments) of GH₵200,000.
Project 2: The machine would cost GH₵1,616,000 and would have a net disposal value of GH₵301,000 at the end of Year 5. The project would earn annual cash flows (receipts minus payments) of GH₵500,000.
Dambai Energy Ltd uses the straight-line method of depreciation. Its cost of capital is 15%.
Ignore taxation, inflation, and investment in working capital.

Required
(a) For each of the two projects, calculate:
(i) the net present value, and
(ii) the internal rate of return to the nearest one per cent.

(b) State which project, if any, you would select for acceptance.

Answer

Find Related Questions by Tags, levels, etc.

Tags: Capital Budgeting, investment appraisal, IRR, NPV, Project Selection
Level: Level 2

Topic: Discounted cash flow

Tag (SQ): Capital Budgeting

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FM – L2 – Q84 – Discounted cash flow

Calculate NPV and estimate IRR for a project with given cash flows and discount rates.

FM – L2 – Q79 – Discounted Cash Flow

Calculate NPV for three investment projects with varying cash flows and discount rates for Zenith Solutions Ltd.

FM – L2 – Q73 – Discounted Cash Flow

Calculate the breakeven rate of return for Kofi's taxi service project using NPV criteria with given cash flows and costs.

FM – L2 – Q72 – Discounted cash flow

Calculate NPV for two machines with given cash flows, tax, and capital allowances.

FM – L2 – Q52 – Discounted cash flow

Calculate NPV and IRR for two mutually exclusive projects for Dambai Energy Ltd.

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FM – L2 – Q84 – Discounted cash flow

Calculate NPV and estimate IRR for a project with given cash flows and discount rates.

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FM – L2 – Q79 – Discounted Cash Flow

Calculate NPV for three investment projects with varying cash flows and discount rates for Zenith Solutions Ltd.

You're reporting an error for "FM – L2 – Q79 – Discounted Cash Flow"

FM – L2 – Q73 – Discounted Cash Flow

Calculate the breakeven rate of return for Kofi's taxi service project using NPV criteria with given cash flows and costs.

You're reporting an error for "FM – L2 – Q73 – Discounted Cash Flow"

FM – L2 – Q72 – Discounted cash flow

Calculate NPV for two machines with given cash flows, tax, and capital allowances.

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FM – L2 – Q52 – Discounted cash flow

Calculate NPV and IRR for two mutually exclusive projects for Dambai Energy Ltd.

You're reporting an error for "FM – L2 – Q52 – Discounted cash flow"

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