ABMF4024 Business Finance Tutorial 9 Answer 23 December 2010

Question 1
Yea PV of CFs (not repeated)
CFs(RM)
r
0 (180,000) (180,000) CF
Yea
1 160,000 142,857.14 NPV = ¿ ¿ s
CFs (RM) PV of CFs ( repeated)
2r 170,000 135,522.96
0
3 (180,000)
- (180,000)
-
1
4 160,000
- 142,857.14
-
2 (10,000)
NPVs= (7,971.94)
98,380.10
3 160,000 113,887.11
4 170,000 108,039.40
NPVs= 176,811.71

Year CFL (RM) PV of CFL

(200,000
0 (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= 153,966.32

a) i) If both projects are not repeated and mutually exclusive, choose PROJECT L.
ii) If both projects are repeated and mutually exclusive, choose PROJECT S.
iii) If both projects are repeated and independent, choose BOTH PROJECTS L & S.

Question 2
a)
Yea Project A
Project B (RM) PVIF10% PV – A PV – B
r (RM)
0 (10,000) (7,000) 1 10,000 7,000
1 10,000 5,0000.9091 9,091 4,545.5
2 2,000 (12-10) 5,0000.8264 1,652.98 4,132
3 10,000 6,0000.7513 7,513 4,507.8
4 12,000 7,0000.6830 8,916 4,781
NPV = 16,452.8 10,966.3
Based on the NPV, Project A should be chosen on has higher NPV

b) If the project are independent, both will be chosen if there are unlimited funds
If they are mutually exclusive, then Project A will 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 required to recover the entitled
investment. The payback period is calculated by adding up the cash flows until they are equal to the
initial fixed investment
ii. Although the measures does, deal with cash flows and it is easy to calculate and under it and, it
ignores any cash flow that occur after the payback period and does not consider 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 assigning negative value to cash outflows. It becomes

n
CF
NPV =∑ ¿ ¿ t ¿
t=0
The accepted criteria are:
Accept if NPV ≥ 0
Reject if NPV ¿ 0

c) Profitability index
The profitability index is the ratio of the present value of the expected future net cash flows to the initial
cash outlay or
n
CF
Profitablity Index=∑ ¿ ¿ t ¿
t−1
Accept if PI ≥ 1.0
Reject if PI ¿ 1.0

d) internal rate of return

The internal rate of return is the discount rate that equates the present value of the project’s future net
cash flows with the project’s initial outlay. Thus, the internal rate of return is represented by IRR in the
equation below:
n
CF
NPV =∑ ¿ ¿ t ¿
t=1

Accept if IRR ≥ required rate of return

Reject if IRR ¿ required rate of return

Adv. – it deals with cash flows and recognizes 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 fixed
assets (LT decision)  impact firm future
Ability to payback (affect payback period)

Can’t be liquidated
If error occur  costly and difficult to reverse

Not easy to sell unwanted

i.e: machine previously bought

Question 5
Yea
CFL (RM) PV of CFL (r=10%)
r
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) Payback period = 4 + 100/600 = 4.17
CF
0 (2,500) (2,500) The project can be accepted, since the payback period is less
1 600 (1,900) than 5 year.
2 600 (1,300)
3 600 (700)
4 600 (100)
5 600 500
6 600 1,100
NPV (r=2%) = RM860.86
NPV (r=12%) = RM-33.16

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 the interest rate over time.  Thus, an increase in the 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, CF1-8 = 12000, I/YR = 12, and then solve
for NPV = $7,486.68.
ii. Financial calculator solution: Input CF0 = -52125, CF1-8 = 12000, and then solve for IRR =
16%.
iii. MIRR: PV costs = $52,125.

FV inflows:

PV FV
0 12%
1 2 3 4 5 6 7 8
| | | | | | | | |
12,000 12,000 12,000 12,000 12,000 12,000 12,000 12,000
 1.12

 (1.12)2
13,440
15,053
 (1.12)3
16,859
 (1.12)
4

 (1.12)
5
18,882
 (1.12)
6
21,148
 (1.12)
7
23,686
26,528
52,125 MIRR = 13.89% 147,596

Financial calculator solution: Obtain the FVA by inputting N = 8, I/YR = 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 projects, investors require a higher rate of return 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 rates of return, and again in such a case, we would resort to NPV.