ABMF4024 Business Finance
Tutorial 9 Answer
23 December 2010
Question 1 Year
CFs(RM)
PV of CFs (not repeated)
0
(180,000)
(180,000)
1
160,000
142,857.14
2
170,000
135,522.96
3
-
-
4
-
-
NPVs=
98,380.10
Year
CFs (RM)
PV of CFs ( repeated)
0
(180,000)
(180,000)
1
160,000
142,857.14
2
(10,000)
(7,971.94)
3
160,000
113,887.11
4
170,000
108,039.40
NPVs=
176,811.71
Year
CFL (RM)
PV of CFL
0
(200,000)
(200,000)
1
110,000
98,214.29
2
110,000
87,691.33
3
120,000
85,415.33
4
130,00
82,618.37
NPVs= a)
i)
153,966.32
If both projects are not repeated and mutually exclus ive, choose PROJECT L.
ii) iii)
If both projects are repeated and mutually exclus ive, choose PROJECT S. If both projects are repeated and independent, choose BOTH PROJECTS L & S.
Question 2 a) Year
Project A (RM)
Project B (RM)
PVIF10%
PV A
0
(10,000) (10, 000)
(7,000)
1
10,000
7,000
1
10,000
5,000
0.9091
9,091
4,545.5
2
2,000 (12-10)
5,000
0.8264
1,652.98
4,132
3
10,000
6,000
0.7513
7,513
4,507.8
4
12,000
7,000
0.6830
8,916
4,781
16,452.8
10,966.3
NPV =
PV B
Based on the NPV, Project A should be chosen on has higher NPV b)
If the project are independent, bot h will be chosen if there are unl imited funds If they are mutually exclus iv e, then Project A w ill be chosen
ABMF4024 Business Finance
Tutorial 9 Answer
23 December 2010
Question 3 Methods of evaluating Project a) Payback Period Method i.
The payback period of an investment fells the number of requ ired to recover the entitled investment.
The payback period is calculated by adding up the cash flows unt il they are equal to the
initial f ixed investment ii.
Although the measures does, deal w ith cash flows and it is easy to calculate and under it and, it ignores
any cash flow that occur after the payback per iod and does not cons ider the time value of
money within the payback period. b) Present Value Method The net present
value
of an investment project is the present value of the cash inflows minus the
present value of cash outflows by ass igning negative value to cash outflows. It becomes
The accepted criteria are:
0 Reject f NPV 0
Accept if NPV i
c) Prof itability index The prof itability index is the ratio of the present value of the expected future net cash flows to the initial cash outlay or
1.0 Reject f PI 1.0
Accept if PI i
d)
internal
rate of return
The internal rate of return is the discount rate that equates the present value of the projects future net cash flows with the projects initial outlay. Thus, the internal rate of return is represented by IRR in the equation below:
requ red rate of return Reject f IRR requ red rate of return
Accept if IRR i
i
i
Adv. it deals with cash flows and recogn izes the time value of money Disadv the procedures is complicated and time consuming
ABMF4024 Business Finance
Tutorial 9 Answer
23 December 2010
Question 4 Capital
Budgeting Decision is important because it analyze (forecast
CFs)
of potential investment to f ixed
assets (LT dec ision) impact f irm future Ability to payback (affect payback per iod) Cant
be liquidated
If error occur costly and diff icult to reverse Not easy to sell unwanted i.e:
machine previously bought
Question 5 Year
CFL (RM)
PV of CFL(r=10%)
0
(3,000)
(200,000)
1
800
727.27
2
800
661.16
3
800
601.05
4
800
546.41
5
800
496.74
6
800
451.58
NPVs=
RM484.21
The NPV of this project is RM484.21, which the NPV is greater than 0, it is worth to pursuing.
Financial calculator method: (3000), CFj, 800, CFj, 6, Nj, 10% I/Y, IRR. IRR = 15.34%
Question 6 Cumulative
Year
CFL (RM)
0
(2,500)
(2,500)
1
600
(1,900)
2
600
(1,300)
3
600
(700)
4
600
(100)
5
600
500
6
600
1,100
CF
NPV(r=2%) =
RM860.86
NPV(r=12%) =
RM-33.16
Payback period = 4 + 100/600 = 4.17 The project can be accepted, acc epted, since the payback period is less than 5 year.
When
the discount rate is 2%, NPV is RM860.86, which shows positive NPV. The project can be pursued. If discount rate is 12%, NPV will be less than 0. The firm will not pursue the project. As conclusion, the firm¶s decision change as the discount rate change.
ABMF4024 Business Finance
Tutorial 9 Answer
23 December 2010
Question 7 The WACC is obtained by discounting future cash flows, and the discounting process actually compounds compounds the interest rate over over time. Thus, an increase in the discount discount rate has a much greater impact on a cash flow in Year 5 than on a cash flow in Year 1.
Question 8 i.
Financial calculator solution: Input CF0 = -52125, CF 1-8 = 12000, I/YR = 12, and then solve for NPV = $7,486.68.
ii.
Financial calculator calculator solution: solution: Input CF0 = -52125, CF 1-8 = 12000, and then solve for IRR = 16%.
iii.
MIRR: PV costs = $52,125.
FV inflows: PV 0
FV 12%
|
1
2
3
4
5
6
7
8
|
|
|
|
|
|
|
|
12,000
12,000
12,000
12,000
12,000
12,000
12,000 v
v
v
v
v
v
1.12
(1.12) 2
(1.12) 3
(1.12)4
(1.12) 5
(1.12) 6
(1.12)7
v
52,125
MIRR = 13.89%
12,000 13,440 15,053 16,859 18,882 21,148 23,686 26,528 147,596
Financial calculator solution: Obtain the FVA by inputting inputting N = 8, I/YR = 12, 12, PV = 0, PMT = 12000, and then solve for FV = $147,596. The MIRR can be obtained by inputting N = 8, PV = -52125, PMT = 0, FV = 147596, and then solving for I/YR = 13.89%.
ABMF4024 Business Finance
Tutorial 9 Answer
23 December 2010
Question 9 The above statement implies that IRR and NPV would lead to different conclusions if the projects are mutually exclusive, have different
WACC,
and/or uneven cash flows.
If the WACC are different, this would mean that there is a difference in the riskiness of the projects, and since for riskier riski er projects, investors require a higher rate of return ret urn therefore neither the IRR nor the NPV of the projects could be compared. If the projects are mutually exclusive (undertaking one of the projects means that the other cannot be undertaken), IRR can be misleading and the rule in this case would be to undertake the project with the highest NPV. Finally, if the cash flows are uneven (positive cash flows followed by negative cash flows), the IRR would provide multiple multiple rates of return, and again aga in in such a case, we would resort to t o NPV.