investment appraisal – Page 3

FM – L2 – Q51 – Introduction to investment appraisal

State two justifications for payback period and one for ARR as investment appraisal techniques.

Question

ZESTA VENTURES

It is said that of all the capital investment evaluation approaches, the Payback (PB) and Accounting rate of return (ARR) methods are widely used in practice. But these methods are not without limitations.

Required:

(a) State TWO justifications of payback period and ONE justification of ARR for their popularity in practice as investment appraisal techniques.

(b) Outline TWO limitations each for payback and ARR, as investment appraisal techniques.

Answer

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Tags: Accounting rate of return, Financial decision-making, investment appraisal, Limitations, Payback period
Level: Level 2

Topic: Introduction to Investment Appraisal

FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

Question

Akomo Plastics Plc is engaged in plastics manufacture. It is now considering a new investment that would involve diversification into chemicals manufacture, where the business risk is very different from the plastics manufacturing industry.
Research has produced the following information about three companies currently engaged in chemicals manufacturing, in the same part of the industry that Akomo Plastics Plc is planning to invest.

Company	Equity beta	Financed by:
A	2.66	40% equity capital, 60% debt capital
B	1.56	75% equity capital, 25% debt capital
C	1.45	80% equity capital, 20% debt capital

Akomo Plastics Plc is financed by 60% equity capital and 40% debt capital, and would intend to maintain this same capital structure if the new capital investment is undertaken.
The risk-free rate of return is 5% and the return on the market portfolio is 9%. Tax is at the rate of 25%. You should assume that the debt capital of Akomo Plastics Plc and Companies A, B and C is risk-free.

Required
(a) Calculate a suitable cost of equity for the proposed investment by Akomo Plastics Plc in chemicals manufacturing.

(b) Suggest a weighted average cost of capital that should be used to carry out an investment appraisal (NPV calculation) of the proposed project.

Answer

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Tags: Asset beta, Capital structure, CAPM, Chemical manufacturing, Cost of Equity, Equity beta, Financial Risk, investment appraisal, Tax shield, WACC
Level: Level 2

Topic: Cost of capital

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

Question

Tema Electrical Plc is considering whether to purchase a machine for the manufacture of a new product, Product X. It has been estimated that Product X would have a life of four years and at a selling price of GH¢8 per unit, annual sales demand would be 400,000 units in Year 1, 600,000 units in Year 2 and 800,000 in each of Years 3 and 4.

Variable production and selling costs would be GH¢6 per unit. Incremental annual fixed cost expenditures (all cash cost items) would be GH¢500,000 in Year 1, rising by GH¢20,000 each year.

The machine, which has an annual output capacity of 700,000 units of Product X, would cost GH¢1,200,000 and would have a resale value of GH¢200,000 at the end of Year 4. Capital allowances would be available on a 25% annual reducing balance basis, with a balancing charge or allowance in the year of disposal. Tax at 25% is payable one year in arrears of the profits to which it relates.

Tema Electrical Plc is financed 70% by equity capital and 30% by debt capital. The equity has a cost of 10% and the debt has a cost of 8.9% (before tax).

Required

Calculate the net present value of the proposed project and recommend whether the investment in the machine should be undertaken.

Answer

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Tags: capital allowances, Cash Flows, Cost of Capital, Discounted cash flow, Financial management, investment appraisal, NPV, project evaluation, Taxation, WACC
Level: Level 2

Topic: Discounted cash flow

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FM – L2 – Q51 – Introduction to investment appraisal

State two justifications for payback period and one for ARR as investment appraisal techniques.

FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

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FM – L2 – Q51 – Introduction to investment appraisal

State two justifications for payback period and one for ARR as investment appraisal techniques.

You're reporting an error for "FM – L2 – Q51 – Introduction to investment appraisal"

FM – L2 – Q38 – Cost of capital

Calculate cost of equity and WACC for Akomo Plastics Plc's investment in chemicals manufacturing using CAPM and given beta data.

You're reporting an error for "FM – L2 – Q38 – Cost of capital"

FM – L2 – Q21 – Discounted cash flow

Calculate NPV for a machine investment at Tema Electrical Plc and recommend if it should be undertaken, considering cash flows, WACC, and tax.

You're reporting an error for "FM – L2 – Q21 – Discounted cash flow"

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