Monday, 18 November 2013
costing paper solutions 1
(i) Define the following:
(a) Imputed cost
(b) Capitalised cost
(ii) Calculate efficiency and activity ratio from the following data:
Capacity ratio = 75%
Budgeted output = 6,000 units
Actual output = 5,000 units
Standard Time per unit = 4 hours
(iii) List the Financial expenses which are not included in cost.
(iv) Mention the main advantage of cost plus contracts.
(v) A Company sells two products, J and K. The sales mix is 4 units of J and 3 units of K.
The contribution margins per unit are Rs.40 for J and Rs.20 for K. Fixed costs are
Rs.6,16,000 per month. Compute the break-even point.
(vi) When is the reconciliation statement of Cost and Financial accounts not required?
(5×2=10 Marks)
Answer
(i) (a) Imputed Cost: These costs are notional costs which do not involve any cash outlay.
Interest on capital, the payment for which is not actually made, is an example of
Imputed Cost. These costs are similar to opportunity costs.
(b) Captialised Cost: These are costs which are initially recorded as assets and
subsequently treated as expenses.
(ii) Capacity Ratio =
Actual Hours x 100
Budgeted Hours
75% = actual hours
6000 Units 4 hour per unit
(a) Imputed cost
(b) Capitalised cost
(ii) Calculate efficiency and activity ratio from the following data:
Capacity ratio = 75%
Budgeted output = 6,000 units
Actual output = 5,000 units
Standard Time per unit = 4 hours
(iii) List the Financial expenses which are not included in cost.
(iv) Mention the main advantage of cost plus contracts.
(v) A Company sells two products, J and K. The sales mix is 4 units of J and 3 units of K.
The contribution margins per unit are Rs.40 for J and Rs.20 for K. Fixed costs are
Rs.6,16,000 per month. Compute the break-even point.
(vi) When is the reconciliation statement of Cost and Financial accounts not required?
(5×2=10 Marks)
Answer
(i) (a) Imputed Cost: These costs are notional costs which do not involve any cash outlay.
Interest on capital, the payment for which is not actually made, is an example of
Imputed Cost. These costs are similar to opportunity costs.
(b) Captialised Cost: These are costs which are initially recorded as assets and
subsequently treated as expenses.
(ii) Capacity Ratio =
Actual Hours x 100
Budgeted Hours
75% = actual hours
6000 Units 4 hour per unit
Wednesday, 13 November 2013
Tuesday, 12 November 2013
Saturday, 12 October 2013
CHAPTER TEN : INVESTMENT APPRAISAL
CHAPTER TEN : INVESTMENT APPRAISAL
Investment (project) appraisal is a process whereby proposed projects
are appraise in terms of their expected returns. Due to limited resources
available we are to select the project
that yields the highest expected returns. The term investment (project)
appraisal is synonymous to the term capital budgeting. Capital budgeting is the process of planning
expenditure on assets whose cash flows are expected to extend beyond one year.
We will first examine and discuss
some basic concepts necessary for our understanding and application of project
appraisal techniques.
Basic Concepts
Time Value of Money: This
suggests that money has a time value. That is a dollar in hand is worth more
than a dollar to be received in the
future because, if you had it now, you could invest it, earn interest, and end
up with more than one dollar in the future.
Dollars that are paid or
received at two different points in time
are different, and this difference is recognized and accounted for by the time
value of money (TVM) analysis.
Time Line : An important
tool used in time value of money analysis; it is a graphical
representation which used to show the timing of cash flows.
Example of time line:
Present Value : Is the beginning
amount, in your account.
Future Value: This is the amount to which a cash flow or series of
cash flows will grow over a given period of time when compounded at a given interest rate.
Compounding: This is the arithmetic process of determining the
final (future) value of a cash flow or
series of cash flows when compound interest is applied.
i.e. FVn = PV (1 + r)n
Where, PV = Present Value
r = interest rate the bank pays
per year. The interest earned is based on the balance at the beginning of each
year, and it is assume that is paid at the end of the year. Note that r here is
expressed as a decimal. Thus, if r = 5%
it is inputted as 0.05.
n =
number of periods involved in the analysis.
FVn = future value, or ending amount, in your
account at the end of n years.
Capital Expenditure : This is expenditure which results in the
acquisition of fixed assets, or an improvement in their capacity. Capital
expenditure is not charged as an expense in the profit and loss account of a
business enterprise, although a depreciation charge will usually be made to
write off the capital expenditure gradually over time. Instead capital
expenditure in fixed assets results in the appearance of a fixed asset in the
balance sheet of a business.
Revenue Expenditure is an expenditure which is incurred for the
purpose of the trade of the business or to maintain the existing earning capacity
of the fixed assets.
Capital Investment involves expenditure on fixed assets for use in
a project which is intended to provide a return by way of interest, dividends
or capital appreciation.
Methods of Appraisal for Capital Projects
1. Accounting Rate of Return (ARR)
The ARR is the ratio of average
profits, after depreciation, to the capital
invested. This is a basic definition only and various interpretations
are possible i.e.
a) Profits may be before or after
tax
b) Capital invested may be the initial
capital invested or the average capital invested over the life of the project
i.e. Initial Investment ÷ 2
c) Capital may or may not include
working capital
Note: Alternative names for the ARR are : Return on Capital
Employed and Return on Investment
Example
A firm is considering three
projects each with an initial investment of GMD2,500 and a life of five years.
The estimated annual profits are as follows:
After Tax and
Depreciation Profits
|
Year
|
Project A
|
Project B
|
Project C
|
|
|
GMD
|
GMD
|
GMD
|
|
1
|
250
|
500
|
100
|
|
2
|
250
|
450
|
100
|
|
3
|
250
|
100
|
100
|
|
4
|
250
|
100
|
450
|
|
5
|
250
|
100
|
500
|
|
Total
|
1,250
|
1,250
|
1,250
|
Calculate the ARR based on:
a) Initial capital invested
b) Average capital invested.
Solution
|
|
Project A
|
Project B
|
Project C
|
|
Average Profits
|
GMD1,250 ÷5 =GMD250
pa.
|
GMD1,250 ÷5 =GMD250
pa.
|
GMD1,250 ÷5 =GMD250
pa.
|
|
|
|
|
|
|
ARR (based on
initial capital of GMD2,500)
|
=(250 ÷ 2,500) x 100% = 10%
|
=(250 ÷ 2,500) x
100% = 10%
|
=(250 ÷ 2,500) x
100% = 10%
|
|
|
|
|
|
|
|
|
|
|
|
ARR (based on
average capital of GMD2,500)
|
=(250 ÷ 1,250) x 100% = 20%
|
=(250 ÷ 1,250) x
100% = 20%
|
=(250 ÷ 1,250) x
100% = 20%
|
|
|
|
|
|
Advantages of ARR
The only advantage that can
claimed for ARR is simplicity of calculation.
Disadvantages of ARR
1. It ignores the timing of
outflows and inflows.
2. Uses a measure of return the
concepts of accounting profit. Profit has subjective elements, is subject to
accounting conventions and is not as appropriate for investment decision making
as the cash flows generated by the project.
3. There is no universally
accepted method of calculating ARR.
2. Payback Period Method
This method measures the time to
be taken to recover the initial investment (capital outlay). The method is
particularly relevant if there are liquidity problems, or if distant forecast are
very uncertain.
The payback period method was the
first formal method used to evaluate
capital budgeting projects.
Decision Rule: The shorter the payback period, the better the project
Example One
Consider the case of two machines
for which the following is available:
|
|
Machine P
|
Machine Q
|
|
|
₤
|
₤
|
|
Cost
|
10,000
|
10,000
|
|
Cash inflow year
|
|
|
|
1
|
1,000
|
5,000
|
|
2
|
2,000
|
5,000
|
|
3
|
6,000
|
1,000
|
|
4
|
7,000
|
500
|
|
5
|
8,000
|
500
|
Calculate the payback period for
each of the project and state which one of the projects should be chosen.
Solution
Machine P
|
|
Cash Flow (CF)
|
Cumulative Cash
Flow (CCF)
|
|
|
₤
|
₤
|
|
0
|
(10,000)
|
(10,000)
|
|
1
|
1,000
|
(9,000)
|
|
2
|
2,000
|
(7,000)
|
|
3
|
6,000
|
(1,000)
|
|
4
|
7,000
|
|
|
5
|
8,000
|
|
Note: The payback period is more than three years but less than
four years. This is so because the balance of the outlay to be recovered at the
end of the three year period is just ₤1,000, which is less than the cash flow
of ₤7,000 in the year four. Therefore
the payback period is between three and four years.
The payback period is therefore
calculated as follows:
Payback Period = 3 years + (1,000
/ 7,000) = 3.14 years
Machine Q
|
|
Cash Flow (CF)
|
Cumulative Cash
Flow (CCF)
|
|
|
₤
|
₤
|
|
0
|
(10,000)
|
(10,000)
|
|
1
|
5,000
|
(4,000)
|
|
2
|
5,000
|
|
|
3
|
1,000
|
|
|
4
|
500
|
|
|
5
|
500
|
|
Note: The payback period is just two years. This is so because the
balance (₤5,000) of the outlay to be recovered at the end of the two year
period.
The payback period is 2 years.
Therefore, machine P pays back
after 3 years 1 month and machine Q at the end of year two.
Since the project with a shorter payback period should be preferred,
therefre machine Q should be chosen.
Example Two
Consider the following:
|
|
₤
|
|
Outlay – Project Cost
|
80,000
|
|
- Working Capital Investment
|
10,000
|
|
Inflow – year
|
|
|
1
|
30,000
|
|
2
|
40,000
|
|
3
|
40,000
|
|
4
|
50,000
|
Calculate the project’s payback period.
Solution
|
Year
|
Cash Flow (CF)
|
Cumulative Cash
Flow (CCF)
|
|
|
₤
|
₤
|
|
0
|
(90,000)
|
(90,000)
|
|
1
|
30,000
|
(60,000)
|
|
2
|
40,000
|
(20,000)
|
|
3
|
40,000
|
|
|
4
|
50,000
|
|
|
5
|
8,000
|
|
Thus, the payback period = 2
years + (20,000 / 40,000) = 2.5 years
Advantages of the Payback Period
Ø
It is simple to understand and explain,
Ø
It is risk reducing measure.
Ø
It has the correct emphasis for firm with
limited cash resources.
Disadvantages of the Payback Period
Ø
It does not appraise the whole period of the
investment (i.e it ignores any cash flows that occur after the project has paid
for itself.
Ø
It ignores the time value of money.
Ø
The selection of a target payback period may be arbitrary
Ø
Total profitability is ignored.
Discounted Cash Flows (DCF) Methods
There are two basic DCF methods,
namely; Net Present Value (NPV) and Internal Rate of Return (IRR).Both methods
recognize the time value of money, the time preference for receiving the same
sum of money sooner rather than later.
Before going further it is important
to know that only relevant costs need to be considered in our project
appraisal. Relevant cost are costs incurred as a result of taking up the
project. Non-relevant cost, such as depreciation and sunk costs are to be
ignored.
Depreciation is a non-cash flow item and should therefore be
ignored.
Sunk Costs are expenses / costs already incurred, well before the
project starts. They include; land already bought and any other expenses /
expenditure already made.
Discounting and Compound Interest
If we were to invest GMD1,000 now
in a bank account which pays interest of 10%
per annum, with interest calculated once each year at the end of the
year, we would expect the following returns:
(a) After one year, the
investment would rise in value to:
GMD1,000 + (GMD1,000 x 10%) = GMD1,000 (1 + 10%) = GMD1,000
x 1.10 = GMD1,100
Interest for the year would be GMD100
, i.e. 10% x GMD1,000. We can say that the rate of simple interest is 10%.
(b) If we keep all our money in
the bank account, after two years the investment would now be worth:
GMD1,100 x 1.1 = GMD1,210
i.e. GMD1,000 x (1.10) x (1.10) =
GMD1,000 x (1.10)2 = GMD1,210
Interest in year two would be : GMD1,210
- GMD1,100 = GMD110
Similarly, if we keep the money
invested for further year, the investment would grow to GMD1,000 x (1.10) x
(1.10) x (1.10) = GMD1,000 x (1.10)3 = GMD1,331 at the end of the
third year. Interest in year three would be : GMD1,331 - GMD1,210 = GMD121.
This example show how compound
interest works, Compound interest arises when accrued interest is added to the
capital outstanding and it is this revised balance on which interest is
subsequently earned.
A formula which can be used to
show the value of an investment after several years which earns compound
interest is:
F = P x (1 + r)n
Where,
F = future value of the
investment after n years
P = the amount invested now , i.e . the present value
r = the rate of interest, as a
proportion for example. 10% = 0.10
n = the number of years of the
investment
Note : The present value is the cash equivalent now of a sum
receivable or payable at a future date. The formula for the Present Value (P)
of a single sum, F receivable in n years’ time, given the interest rate ( a
discount rate) r is given by:
P = F x 1 / (1 + r)n
The Net Present Value (NPV) Method of DCF
The NPV method of evaluation is as follows:
(a) Determine the present value
of costs. Let this “C”.
(b) Calculate the present value
of future cash benefits from the project. To do this we take the cash benefit
in each year and discount it to a present value. By adding up the present value
of the benefits for each future year, we obtain the total present value of
benefits from the project. Let this “B”.
(c) Compare the present value of
cost “C” with the present value of
benefits “B”. The NPV is the difference between them : GMDB - GMDC.
(d) Decision Rule:
Ø
If the
NPV is positive accepts / take the project. This means that the present
value of benefits exceeds the present value of cost. It also means that the
project will earn a return in excess of the cost of capital.
Ø
If the
NPV is negative reject, that is don’t
take the project. The negative NPV means that it would cost us more to
invest in the project to obtain the future cash receipts than it would cost us
to invest somewhere else, at rate of interest equal to the cost of capital, to
obtain an equal amount of future receipts.
Examples
1. Suppose that a company is
wondering whether to invest GMD18,000 in a project which would make extra
profits (before depreciation is deducted) of
GMD10,000 in the first year, GMD8,000 in the second year and GMD6,000 in
the third year. Its cost of capital is 10% (in other word, it would require a
return of at least 10% on its investment). Advise the company whether it should
take on this project or not.
Solution
|
Year
|
Cash Flow
GMD
|
Present Value Factor@10%
1 / 1+1.10)n
|
Present Value
GMD
|
|
0
|
(18.000)
|
1.000
|
(18,000)
|
|
1
|
10,000
|
0.909
|
9,090
|
|
2
|
8,000
|
0.826
|
6,608
|
|
3
|
6,000
|
0.751
|
4,506
|
|
|
|
|
NPV = 2,204
|
Since the
project’s NPV is positive it means that the project will earn more than 10%. Therefore the project should be accepted.
2. A project
would involve a capital outlay of GMD24,000. Profit (before depreciation) each
year would be GMD5,000 for six years. The cost of capital is 12. Is the project
worthwhile?
Solution
|
Year
|
Cash Flow
GMD
|
Present Value Factor@12%
1 / 1+1.12)n
|
Present Value
GMD
|
|
0
|
(24.000)
|
1.000
|
(24,000)
|
|
1
|
5,000
|
0.893
|
4.465
|
|
2
|
5,000
|
0.797
|
3,985
|
|
3
|
5,000
|
0.712
|
3,560
|
|
4
|
5,000
|
0.636
|
3,180
|
|
5
|
5,000
|
0.567
|
2,835
|
|
6
|
5,000
|
0.507
|
2,535
|
|
|
|
|
NPV = (3,440)
|
The project’s NPV is negative and
so the project is not worthwhile.
Annuities
In discounted cash flow the term
‘annuity’ refers to an annual cash payment which is the same amount every year
for a number of years, or also an annual receipt of cash which is the same
amount every year for a number of years.
The general equation used to find
the present value of an annuity (PVA) is
as follows:
i.e. PVA = PMT (1 / (1+r)1) + PMT (1 / (1+r)2) + PMT (1 / (1+r)3) +
........+ PMT (1 / (1+r)n)
Using geometric progression solution process the PVA is found to be:
i.e PVA = PMT(1 / r ) ( 1 – (1 / 1+r)n) Equation **
Thus use equation ** above to
answer annuities questions. Where (1 / r
) ( 1 – (1 / 1+r)n) is the discount factor for the annuities.
Examples
1. A project would involve a
capital outlay of GMD50,000. Profit
before depreciation would be GMD12,000 per year. The cost of capital is 10%.
Would the project be worthwhile if it last the following number of years?
(a) Five years.
(b) Seven years.
Solution
(a) When n = 5 years, then the
discount factor is:
i.e. discount factor = (1 / 0.1 ) ( 1 – (1 / 1.10)5) =
3.791
|
Year
|
Cash Flow
GMD
|
Present Value Factor@10%
1 / 1+1.10)n
|
Present Value
GMD
|
|
0
|
(50.000)
|
1.000
|
(50,000)
|
|
1-5
|
12,000 per annum
|
3.791
|
45,492
|
|
|
|
|
PVA = (4,508)
|
The project is not worthwhile if
it last only for five years, since its NPV (PVA) is negative.
(a) When n = 7 years, then the
discount factor is:
i.e. discount factor = (1 / 0.1 ) ( 1 – (1 / 1.10)7) =
4.868
|
Year
|
Cash Flow
GMD
|
Present Value Factor@10%
1 / 1+1.12)n
|
Present Value
GMD
|
|
0
|
(50.000)
|
1.000
|
(50,000)
|
|
1-7
|
12,000 per annum
|
4.868
|
58,416
|
|
|
|
|
PVA = 8,416
|
The project would be worthwhile
if it last for seven years since its NPV (PVA) is positive. The decision to
accept or reject the project must depend on management view about its duration.
2. A project would cost GMD39,500.
It would earn GMD10,000 per year for the first three years and then GMD8,000 per year for the next three years. The cost
of capital is 10%. Is the project worth undertaking?
Solution
When n = 3, the discount factor :
i.e. discount factor = (1 / 0.1 ) ( 1 – (1 / 1.10)3) =
2.487
When n = 6, the discount factor :
i.e. discount factor = (1 / 0.1 ) ( 1 – (1 / 1.10)6 ) =
4.355
Therefore the discount factor for the period 4 – 6 would be = 4.355 –
2.487 = 1.868
|
Year
|
Cash Flow
GMD
|
Present Value Factor@10%
1 / 1+1.10)n
|
Present Value
GMD
|
|
0
|
(39.500)
|
1.000
|
(39,500)
|
|
1-3
|
10, 000 per annum
|
2.487
|
24,870
|
|
4-6
|
8,000 per annum
|
1.868
|
14,944
|
|
|
|
|
PVA = 314
|
The NPV is positive, but only
just GMD314. The project therefore promise a return a little above 10%.
If we are confident that the
estimates of cost and benefits for the next six years are accurate, the project
is worth undertaking. However, if there is some suspicion that earnings may be
a little less than the figures shown, it might be prudent to reject it.
Exercise
A project should involve the purchase of some
plant for GMD25,000 and an investment in working capital of GMD6,000. It would
earn GMD10,000 per year for four years. The cost of capital is 9%. Is the
project worthwhile?
Internal Rate of Return (IRR)
The IRR is that discount rate
which gives an NPV of zero. It is useful
for ‘conventional’ projects where once cash outflow is followed by a series of
inflows.
The IRR method involves two
steps:
(a) Calculate the rate of return
which is expected from a project.
It is general calculated by trial
and error interpolating between one discount rate that gives a positive NPV and
another that gives a negative NPV. A formula for making this calculation (which
is known as interpolation) is as follows:
i.e. IRR = A + { ((a ÷
(a+b)) x (B-A)%}
where A = the discount rate which
provides the positive NPV
a = the amount of positive NPV
B = the discount rate which provides
the negative NPV
b = the amount of negative NPV but the minus sign is ignored.
The IRR Decision Rule:
(a)
Accept the project when the IRR is more than the target rate of return of cost of capital.
(b)
Reject the project when the IRR is less than the target rate of return or cost of capital.
Examples
1. A machine requires an outlay
of GMD1.5 million to produce three annual inflows of GMD0.7 million. Estimate
the IRR, given NPV at 10% to be GMD241,000,
at 20% to be GMD(26,000) and decide whether the machine should be
bought.
Solution
IRR = A + { ((a ÷ (a+b)) x (B-A)%}
Where A = 10%, a = GMD241,000
B = 20% , b = GMD26,000
IRR = 10% + { ((GMD241,000 ÷
(GMD241,000+GMD26,000)) x (20-10)%} = 19%
Since the IRR (19%) is more than
the cost of capital of 10% , then it means that the machine should be bought.
2. Suppose that a project would
cost GMD20,000 and the annual net cash inflows are expected to be as follows:
|
Year
|
Cash Flow
GMD
|
|
1
|
8,000
|
|
2
|
10,000
|
|
3
|
6,000
|
|
4
|
4,000
|
What is the internal rate of
return of the project?
Solution
The IRR is the rate of interest
at which the NPV is zero and the discounted (present) values of benefits add up
to GMD20,000.
Thus, we need to find out what
interest rate or cost of capital would give an NPV of zero.
We might begin by trying discount
rates of 10% , 15% and 20%.
|
Year
|
Cash Flow
GMD
|
Discount Factor
@10%
|
Present Value
@10%
GMD
|
Discount Factor
@15%
|
Present Value
@15%
GMD
|
Discount Factor
@20%
|
Present Value
20%
GMD
|
|
0
|
(20,000)
|
1.000
|
(20,000)
|
1.000
|
(20,000)
|
1.000
|
(20,000)
|
|
1
|
8,000
|
0.909
|
7,272
|
0.870
|
6,960
|
0.833
|
6,664
|
|
2
|
10,000
|
0.826
|
8,260
|
0.756
|
7,560
|
0.694
|
6,940
|
|
3
|
6,000
|
0.751
|
4,506
|
0.658
|
3,948
|
0.579
|
3,474
|
|
4
|
4,000
|
0.683
|
2,732
|
0.572
|
2,288
|
0.482
|
1,928
|
|
NPV
|
|
|
2,770
|
|
756
|
|
(994)
|
The IRR is more than 15% but less
than 20%.
Thus, using the IRR formula,
IRR = A + { ((a ÷ (a+b)) x
(B-A)%}
Where A = 15%, a = GMD756
B = 20% , b = GMD(994)
IRR = 15% + { ((756 ÷ (756+994)) x (20-15)%} = 15% + 2.16% = 17.16%
Advantage of the IRR Method
The IRR is fairly easily
understood since it is expressed in percentage terms.
Disadvantages of the IRR Method
Ø
It ignores the relative size of investments
Ø
The method gives either no IRR or multiple IRRs
in a ‘non-conventional’ projects. A non-conventional project is one where the
direction of cash flows varies during the course of the project (i.e. when
there are changes in sign in the pattern of cash flows). In such cases use the NPV method
Note: The NPV is always the preferred method. So when there
is a conflict in the decision rule between the IRR and the NPV, the NPV rule is
chosen. That is:
.
(a) If the NPV methods says we
accept the project but the IRR method advices us to reject the project we
should go by the NPV decision rule.
(b) Similarly , if the NPV method
says we reject the project but the IRR advices us to accept the project we
should go by the NPV decision rule.
Thus, the project should be rejected.
Sensitivity Analysis
This is one of the most useful
and widely used techniques for allowing for risks. When a project is evaluated
a large number of assumptions (or forecast) have to be made. For example,
estimates would have to be made about the life of the project, its annual revenues,
its annual labour costs, its annual material costs; etc.
Suppose that all these estimates
are made and, on the basis of an NPV analysis, the project has a +NPV of GMD250.
Therefore the investment decision advice is to accept.
What sensitivity analysis does is
to look to see by how much each individual estimate can change before the
decision advice “to accept” is overturned, (i.e. the NPV becomes negative).
This analysis will enable
management to identify which estimates are particularly critical to the NPV
advice. For example suppose the sensitivity analysis indicated that the annual
labour costs would only have to be 5% higher than estimated for the NPV to
become negative. Management would then be able to re-examine the labour cost
estimate to try and ensure that it is as accurate as possible.
PRACTCE QUESTIONS
1. DEC
Ltd has a limited capital budget available for investment in suitable projects
this year, and has short-listed two possible choices. Details are as follows:
Project
A Project B
Capital
cost GMD2,800,000 GMD2,800,000
Expected
life 5
years 5 years
Residual
value nil nil
Budgeted
cash inflows: GMD000 GMD000
Year
1 700 800
Year
2 1,100 1,200
Year
3 1,300 1,300
Year
4 700 600
Year
5 200 300
The
cost of capital to DEC Ltd is 8%.
Extracts
from NPV tables are as follows;
Year 8% 10% 12%
1 .926 .909 .893
2 .857 .826 .797
3 .794 .751 .712
4 .735 .683 .636
5 .681 .621 .567
REQUIRED
a) Calculate the payback period for EACH
project. [3]
b) Calculate the accounting rate of return for
EACH project. [4]
c) Calculate the NPV for EACH project. [8]
d) State which project you would recommend (if
any). [1]
2. CAR
Ltd has a limited capital budget available for investment in suitable projects
this year, and has short-listed two possible choices. Details are as follows:
Project
A Project B
Capital
cost GMD2,800,000 GMD2,800,000
Expected
life 5 years 5 years
Residual
value nil nil
Budgeted
cash inflows: GMD000 GMD000
Year
1 700 800
Year
2 1,000 1,100
Year
3 1,300 1,800
Year
4 1,000 700
Year
5 600 200
The
cost of capital to CAR Ltd is 8%.
Extracts
from NPV tables are as follows:
Year 8% 9% 10%
1 .926 .917 .909
2 .857 .842 .826
3 .794 .772 .751
4 .735 .708 .683
5 .630 .650 .621
REQUIRED
a) Calculate the payback period for EACH
project. [3]
b) Calculate the accounting rate of return for
EACH project. [4]
c) Calculate the NPV for EACH project. [8]
d) Explain which project you would recommend
(if any). [5]
3. REM Ltd has a limited capital budget
available for investment in suitable projects this year, and has short-listed
two possible choices. Details are as follows:
Project
A Project B
Capital
cost GMD1,800,000 GMD1,800,000
Expected
life 5 years 5 years
Residual
value nil nil
Budgeted
cash inflows: GMD000 GMD000
Year
1 800 600
Year
2 1,000 900
Year
3 1,200 1,500
Year
4 700 800
Year
5 300 200
The
cost of capital to REM Ltd is 8%.
Extracts
from NPV tables are as follows:
Year 8% 9% 10%
1 .926 .909 .893
2 .857 .826 .793
3 .794 .751 .712
4 .735 .683 .567
5 .630 .621 .507
REQUIRED
a) Calculate the payback period for EACH
project. [3]
b) Calculate the accounting rate of return for
EACH project. [4]
c) Calculate the NPV for EACH project. [8]
d) Explain fully which project you would recommend. [5]
4, You work in the management accounts
department of a large organisation, which is in the process of allocating funds
to one project from a choice of two.
The
following data applies:
Project X Y
Original
investment 2,600,000 2,600,000
Net
surplus returns:
Year
1 600,000 400,000
Year
2 800,000 700,000
Year
3 900,000 1,000,000
Year
4 500,000 700,000
Year
5 200,000 400,000
The
firm’s average cost of capital is 8%.
Discount
factors 8% 10%
Future
years:
1 .926 .909
2 .857 .826
3 .794 .751
4 .735 .683
5 .681 .650
6 .630 .564
REQUIRED
a) Calculate the payback period, for both
projects. [3]
b) Calculate the accounting rate of return, for
both projects. [4]
c) Calculate the net present value (NPV), for
both projects. [8]
d) State which project, if any, should be
chosen. [1]
e) Explain what ‘non-financial’ factors should
also be considered in the decision-making process. [4]
5. CAM
Ltd has a limited capital budget available for investment in suitable projects
this year, and has short-listed two possible choices. Details are as follows:
Project
X Project Y
Capital
cost GMD1,900,000 GMD1,900,000
Expected
life 5 years 5 years
Residual
value nil nil
Budgeted
cash inflows: GMD000 GMD000
Year
1 800 600
Year
2 900 900
Year
3 1,400 1,600
Year
4 800 900
Year
5 400 200
The
cost of capital to CAM Ltd is 9%.
Extracts
from NPV tables are as follows:
Year 8% 9% 10%
1 .926 .909 .893
2 .857 .826 .793
3 .794 .751 .712
4 .735 .683 .567
5 .630 .621 .507
REQUIRED
a) Calculate the payback period for each
project. [3]
b) Calculate the accounting rate of return for
each project. [4]
c) Calculate the NPV for each project. [8]
d) Explain fully which project you would
recommend. [5]
6. Anderson Ltd has a limited capital budget
available for investment in suitable projects this year, and has short-listed
two possible choices. Details are as follows:
Project
A Project B
Capital
cost GMD2,400,000 GMD2,700,000
Expected
life 5 years 5 years
Residual
value nil nil
Budgeted
cash inflows: GMD000 GMD000
Year
1 190 310
Year
2 900 1,000
Year
3 1,200 1,300
Year
4 700 500
Year
5 400 200
The
cost of capital to LBW Ltd is 9%
Extracts
from NPV tables are as follows:
Year 9% 10% 11%
1 .920 .909 .893
2 .842 .826 .793
3 .772 .751 .712
4 .708 .683 .567
5 .650 .621 .507
REQUIRED
a) Calculate the payback period for EACH
project. [3]
b) Calculate the accounting rate of return for
EACH project. [4]
c) Calculate the NPV for EACH project. [8]
d) State which project you would recommend (if
any). [1]
e) Explain why it is important to use
investment appraisal techniques, and to monitor actual results. [4]
7.
Explain
why a company will use investment appraisal techniques in the choice of allocating
finance to potential investment projects.
[10]
8. Lucom Ltd is considering investing in a project which has the
following cash flows:
GMD000
Initial investment 2,400
Cash flows:
Year 1 600
Year 2 900
Year 3 1,100
Year 4 900
Year 5 500
The cost of capital is
9%.
Extracts from NPV (DCF)
tables:
Rate
of discount 8% 9% 10%
Year
0 1.000 1.000 1.000
Year
1 .926 .917 .909
Year
2 .857 .842 .826
Year
3 .794 .772 .751
Year
4 .735 .708 .683
Year
5 .681 .650 .621
Year
6 .630 .596 .564
REQUIRED:
a) Calculate the payback period (in years and
months). [2]
b) Calculate the ARR (accounting rate of
return). [2]
c) Calculate the NPV (net present value). [4]
d) Explain briefly if you think that the
project is viable. [4]
9. Homunol plc is considering investing in a
project that has the following cash flows:
GMD000
Initial
investment 3,200
Cash
flows:
Year
one 900
Year
two 1,200
Year
three 1,800
Year
four 1,200
Year
five 600
The
cost of capital is 8%.
Extracts
from NPV (DCF) tables:
Rate
of discount 8% 9% 10%
Year
one .926 .917 .909
Year
two .857 .842 .826
Year
three .794 .772 .751
Year
four .735 .708 .683
Year
five .681 .650 .621
Year
six .630 .596 .564
REQUIRED:
a) Calculate the payback period. [2]
b) Calculate the ARR (accounting rate of
return). [2]
c) Calculate the NPV (net present value). [4]
d) Explain briefly if you think that the
project is viable. [4]
e) Outline any ‘non-financial’ factors that
might be considered by Homunol plc during the decision making process. [4]
f) Explain the importance of a project review.[4]
10. Virginia plc. is considering investing
in a project that has the following cash flows:
GMD000
Initial
investment 2,900
Cash
flows:
Year
one 600
Year
two 1,100
Year
three 1,200
Year
four 500
Year
five 300
The
cost of capital is 8%.
Extracts
from NPV (DCF) tables:
Rate
of discount
8% 9% 10%
Year
one .926 .917 .909
Year
two .857 .842 .826
Year
three .794 .772 .751
Year
four .735 .708 .683
Year
five .681 .650 .621
Year
six .630 .596 .564
REQUIRED:
a) Calculate the payback period. [2]
b) Calculate the ARR (accounting rate of
return). [2]
c) Calculate the NPV (net present value). [4]
d) Explain briefly if you think that the
project is viable. [4]
e) Explain the possible sources of long-term
finance available to Virginia
plc.[8]
11. Etnat Ltd is considering investing in a project which has the
following cash flows:
GMD000
Initial
investment 2,600
Cash
flows:
Year
1 600
Year
2 1,000
Year
3 1,100
Year
4 700
Year
5 300
The
cost of capital is 8%.
Extracts
from NPV (DCF) tables:
Rate
of discount 8% 9% 10%
Year
0 1.000 1.000 1.000
Year
1 .926 .917 .909
Year
2 .857 .842 .826
Year
3 .794 .772 .751
Year
4 .735 .708 .683
Year
5 .681 .650 .621
Year
6 .630 .596 .564
REQUIRED:
a) Calculate the payback period (in years and
months). [2]
b) Calculate the ARR (accounting rate of
return). [2]
c) Calculate the NPV (net present value). [4]
d) Explain briefly if you think that the
project is viable. [4]
e) Explain the purpose of investment appraisal. [4]
f) Explain briefly the role of venture
capitalists. [4]
Subscribe to:
Posts (Atom)