- 1 Marks
AAA – L3 – SA – Q5.9 – Audit-related services
Which term is not associated with prospective financial information?
Find Related Questions by Tags, levels, etc.
Report an error
Tag (SQ): Sensitivity Analysis
Search
500
+ past questions and counting.
- 20 Marks
FM – L2 – Q71 – Discounted Cash Flow
Calculate NPV for a project with GH₵3M equipment cost, 5-year cash flows, and 8% cost of capital, ignoring inflation and taxation.
Question
A company, Zenith Innovations Ltd, is considering an investment in a new project to manufacture and sell a new product with a five-year lifespan. The project requires an investment of GH₵3 million in equipment. The residual value of this equipment after five years will be 30% of its original cost.
The estimates of net cash flows from operations in each year of the project are as follows:
| Year | Net Cash Flow (GH₵) |
|---|---|
| 1 | 400,000 |
| 2 | 800,000 |
| 3 | 800,000 |
| 4 | 700,000 |
| 5 | 400,000 |
These cash flows are based on estimates that the annual increase in cash spending on fixed costs will be GH₵200,000, and the contribution/sales ratio from transactions will be 40%. The company’s cost of capital is 8%.
The management of Zenith Innovations Ltd is aware that actual cash flows could be higher or lower than expected, and sensitivity analysis should be carried out to establish the extent to which costs or revenues could differ from the estimate before the project ceases to have a positive NPV.
The investment in working capital will be minimal. Inflation and taxation should be ignored.
Required
(a) Calculate the net present value of the project.
(b) Carry out sensitivity analysis on the following items:
(i) The cost of the equipment, assuming that the residual value will be 30% of cost.
(ii) The residual value of the equipment.
(iii) Sales revenue.
(iv) Variable costs.
(v) Annual fixed costs.
(c) Comment on the risk in undertaking this project.
Find Related Questions by Tags, levels, etc.
- Tags: investment appraisal, NPV, Project Risk, Risk Assessment, Sensitivity Analysis
- Level: Level 2
- Topic: DCF: Risk and uncertainty
Report an error
- 20 Marks
FM – L2 – Q63 – DCF: Risk and uncertainty
Calculate NPV for two machines under different sales demand levels for Kofi Enterprises Ltd.
Question
Kofi Enterprises Ltd must purchase a new machine for making a new product. There is a choice between two machines, Machine A and Machine B. Each machine has an estimated life of three years with no expected scrap value.
Machine A costs N₦15,000 and Machine B costs N₦20,000.
The variable costs of manufacture would be N₦1 per unit if Machine A is used and N₦0.50 per unit if Machine B is used. The product will sell for N₦4 per unit.
The demand for the product is uncertain. Following some market research, the following estimates of annual sales demand have been made:
| Annual demand (Units) | Probability |
|---|---|
| 2,000 | 0.2 |
| 3,000 | 0.6 |
| 5,000 | 0.2 |
The sales demand in each year will be the same. For example, if the demand is 2,000 units in Year 1, it will be 2,000 units for every year of the project.
Taxation and fixed costs will be unaffected by any decision made.
Kofi Enterprises Ltd’s cost of capital is 6%.
Required:
(a) Calculate the NPV for each of investment options, Machine A and Machine B, for each of the possible levels of sales demand.
(b) Calculate the expected NPV for each of the investment options.
(c) Assume now that the decision is taken to buy Machine A.
(i) Calculate the probability that the NPV of the project will be negative.
(ii) Calculate the minimum annual sales required for the NPV of the project to be positive.
Find Related Questions by Tags, levels, etc.
- Tags: break-even analysis, DCF, investment appraisal, NPV, Probability, Sensitivity Analysis
- Level: Level 2
- Topic: DCF: Risk and uncertainty
Report an error
