FM406 Managing Finance

Exercise: Capital Budgeting.

Problem 1.

The management of Ballarat National Bank is considering an investment in

automatic teller machines. The machines would cost K513,000 each and have
a useful of seven years. The bank’s finance manager has estimated that the
automatic teller machines will save the bank K110,000 per machine during
each year of their life. The machines will have no salvage value. Ignore
company income taxes.

Required:
1. Calculate the payback period for the proposed investment.
2. Calculate the net present value of the proposed investment, assuming a
discount rate of: (a) 8 percent; (b) 10 percent; (c) 12 percent.
3. What can you conclude from your answers to requirements 1 and 2
about the limitations of the payback method?

Problem 2.

Parkes Book Company’s management is considering an advertising program

that would require an initial expenditure of K165,500 and bring in additional
sales over the next five years. The projected additional sales revenue in year 1
is K50,000 (net of associated expenses). The additional sales revenue and
expenses from the advertising program are projected to increase by 10 percent
each year. Ignore company income taxes.

Required:
1. Calculate the advertising program’s net present value, assuming a
required rate of return of 8 percent.
2. Calculate the program’s internal rate of return.