UDE1010/CH7/T5 amiroh@um.edu.

my/Umcced

Tutorial 5
Financial Management
Question 1
Smart Bhd involved in agriculture project. Company still consider investing or not in cocoa
plantation. Your team and you are assigned to evaluate either the project is profitable or not
and when Smart Bhd will get their investment back.

The project required cost of capital at 8% per year with expected project life span of 4 years.
Management estimates the following cash flows from the project with initial investment of
RM6,000,000.
Year Cash Flow
RM
0 6,000,000
1 2,000,000
2 3,000,000
3 2,800,000
4 1,600,000

a) Calculate the following :

i) Payback period
ii) Discounted Payback Period
iii) Net present value
iv) Profitability Index
v) Interest rate return- KIV
b) Should the company invest or not in cocoa plantation?

Question 2

Lela Media Company is in the process of deciding the purchase of an electronic casting
system. Provided below is the after tax cash flow for both systems.

Year System A (RM) System B (RM)

0 (45,000) (43,000)
1 10,000 25,000
2 10,000 (7,000)
3 10,000 14,000
4 10,000 12,000
5 10,000 20,000

The company’s cost of capital is 10% and these projects are mutually exclusive.
a. Calculate the following for both system :
i. Payback period
ii. Discounted Payback Period
iii. Net present value
iv. Profitability Index
v. Interest Rate Return - KIV
b. Which project would be selected and state your reasons.
UDE1010/CH7/T5 amiroh@um.edu.my/Umcced

Question 3
Hook Industries is considering the replacement of one of its old drill presses. Two alternative
replacement presses are under consideration. The relevant cash flows associated with each
drill presses are shown in the following table. The firm’s cost of capital is 15%.

Drill Press A Drill Press B

Initial investment RM85,000 RM60,000

Year Cash inflow
1 RM18,000 RM12,000
2 RM18,000 RM14,000
3 RM18,000 RM16,000
4 RM18,000 RM18,000
5 RM18,000 RM20,000

Calculate the project based on the following capital budgeting techniques and make the
decisions for each technique below:
a) Payback period.
b) Discounted Payback period
c) Net Present Value (NPV)
d) Profitability Index (PI)

Question 4 (Example how to answer Question 5 and 6)

Cencana Berhad is considering two mutually exclusive projects, Project Jebat and Project
Tuah. Both projects require an initial outlay of RM100,000. These projects have different
levels of risk, and the company has decided to use a minimum rate of return of 12% for the
less risky project and 16% for the higher risk project.
Both project have a 5 year expected useful life and have the following probability
distributions and cash flow.

Project Jebat Project Tuah

Probability Annual after tax Probability Annual after tax
cash flow cash flow
0.1 30,000 0.1 25,000
0.4 40,000 0.2 50,000
0.4 35,000 0.4 20,000
0.1 25,000 0.3 40,000
a. Calculate the following for each project:

i. Expected annual after tax cash flow

Suggested answer:

Project Jebat
= 0.1 (RM30,000) + 0.4(RM40,000) + 0.4(RM35,000) + 0.1(RM25,000)
= RM35,500

Project Tuah
= 0.1 (RM25,000) + 0.2(RM50,000) + 0.4(RM20,000) + 0.3(RM40,000)
= RM32,500
UDE1010/CH7/T5 amiroh@um.edu.my/Umcced

ii. Standard deviation

Suggested answer:

Project Jebat
= 0.1(RM30,000-RM35,500)2 + 0.4(RM40,000-RM35,500)2 +

0.4(RM35,000-RM35,500)2 + 0.1(RM25,000-RM35,500)2

= RM3,025,000 + RM8,100,000 + RM100,000 + RM11,025,000

= RM4,717

Project Tuah
= 0.1(RM25,000-RM32,500)2 + 0.2(RM50,000-RM32,500)2 +

= 0.4(RM20,000-RM32,500)2 + 0.3(RM40,000-RM32,500)2 +

= RM5,625,000 + RM61,250,00 + RM62,500,000 + RM16,875,000

= RM12,093

iii. Coefficient of variation

Suggested Answer :

Project Jebat = RM4,717/RM35,500

= 0.13

Project Tuah = RM12,093/RM32,500

= 0.37

b. Which project is more risky and calculate the net present value of each
project. Which project would the company undertake? Why?

Which project is more risky?

To answer this question and to identify which project is more risky you need
based on answer from Coefficient of variation.

Based on both project, you need to compare the answer from (iii). P.Jebat
(0.13) less than P.Tuah (0.37). So it shows that Project Tuah has a higher
coefficient of variation. Therefore Project Tuah is more risky compare to the
Project Jebat.

Calculate the net present value

From above question, it was highlighted rate of return of 12% for the less
risky project and 16% for the higher risk project.
Meaning that, Rate of return for Project Tuah is 16% (higher risk) and Rate of
return Project Jebat is 12%.

Refer Table (PV ANNUITY)

Project Jebat = RM35,500 (PVAIFA12%,5) – RM100,000
= RM35,500 (3.6048) - RM100,000
= RM27,970.40 (POSITIVE NPV)
UDE1010/CH7/T5 amiroh@um.edu.my/Umcced

Refer Table (PV ANNUITY

Project Tuah = RM32,500 (PVIFA16%,5) – RM100,000
= RM32,500(3.2743)
= RM6,414.75 (POSITIVE NPV)
Which project would the company undertake?????why?

Based on the information given, it was mention that both project are mutually
exclusive project. If mutually ex, meaning that if let say u have 10 project, but
you are allowed to choose one which most the best in term of higher NPV.
You not allowed to choose more than one because the project is mutually
exc.
Different with independent project (refer answer on c below).

Therefore, which project should you undertake? Company should invest in

PROJECT JEBAT as it give higher NPV return RM27,970.40 compare to
Project Tuah.

c. If the projects are independent projects, should the company accept both?
Why?
Independent projects mean (you can choose or accept many project as you
can as long as it can give POSITIVE NPV.
Based on the answer from B, both project give positive NPV, so if the project
is independent, company may choose BOTH project or one Project. If
company want to choose one project only which give higher NPV also
acceptable. No limit. Its up to your judgement.

But, if the question say, the project are mutually exclusive (Refer on B) on
third point.

Question 5

Banau Berhad is evaluating two mutually exclusive capital budgeting projects. Both projects
require the same amount of initial outlay totalling RM15 million. Both projects are expected
to have a useful life of five years. However, the annual differential cash flows of the two
projects are highly uncertainty, depending on economic performance. The forecasted annual
tax differential cash flows over the projects’ lives are as follows:

Annual after tax cash flows

Economic condition Probability
Project A Project B

Recession 0.3 RM3 million RM7 million

Normal 0.5 RM5 million RM5 million

Boom 0.2 RM8 million RM3 million

Based on the above information, calculate the following for each of the project:

i. Expected return
ii. Standard deviation
iii. Coefficient of variation
UDE1010/CH7/T5 amiroh@um.edu.my/Umcced

b) If the company decided to use 15% for the less risky project and 24% for the higher
risk project, calculate the net present value of each project. Which project would the
company undertake? Why?
c) If the projects are independent projects, should the company accept both? Why?

Question 6
Billionaire Berhad is analyzing two mutually exclusive capital budgeting projects. Project 1
will require an initial outlay of RM25 million, while Project 2 would require RM28 million. Both
projects are expected to have a useful life of four years. The annual differential after tax cash
flows of the two projects depend highly on the forecasted economic performance. The cash
flows of the projects are as follows:

Annual after tax cash flows

Economic condition Probability
Project 1 Project 2

Recession 0.2 RM8 million RM15 million

Normal 0.6 RM10 million RM12 million

Boom 0.2 RM12 million RM5 million

a. Based on the above information, calculate the following for each of the project:
i. Expected annual after tax differential cash flow
ii. Standard deviation
iii. Coefficient of variation

b. If the company decided to use 13% for the less risky project and 20% for the higher
risk project, calculate the net present value of each project. Which project would the
company undertake? Why?
c. If the projects are independent projects, should the company accept both? Why?