1.

LTC (PIPFA S 2014 Q 1) (Part )

LTC is considering to invest in either of two mutually-exclusive projects, Project A and Project B.
Both projects involve the purchase of machinery with a life of five years.
• Project A: The machine would cost Rs.556,000 and would have a disposal value of
Rs.56,000 at the end of Year 5. The project would earn annual Revenue of Rs.100 / unit
and Expected No. of units to be sold are 7000 units each year .Total cost would be Rs.
500,000 per year.
• Project B: The machine would cost Rs. 1,616,000 and would have a disposal value of Rs.
301,000 at the end of Year 5. The project would expect to earn annual sales revenue of
Rs.1 million and expected operating cost would be Rs. 500,000.
LTC uses the straight-line method of depreciation. Its cost of capital is 15%.
Required:
a) For each of the two projects, calculate: (16-Marks)
(i) The accounting rate of return ratio, over the project life (average annual accounting profit as a
percentage of the average book value of the investment, to the nearest one percent)
(ii) The payback period, to the nearest month
(iii) The net present value, and
(iv) The internal rate of return to the nearest one per cent.
b) State which project, if any, you would select for acceptance.(04-Marks)

2. Target Industries (ICMAP May 2014 Q 5)

(a) Board of Directors of Target Industries is planning to invest Rs.1,000,000 on new project
in order to expand its business. Three trading projects .A., .B. and .C. are being considered, each
involving the immediate purchase of equipment costing Rs.1,000,000. Only one of the three
projects can be undertaken. The equipment for each project will have a useful life equal to that
of the project, with no scrap value and a reducing balance method is used for depreciation.
Projected Net Cash Flow Rs. 000
Years
Year
0 1 2 3 4 5 6 7 8
A (1,000) 286 314 297 320 394 457 514 -
B (1,000) 114 286 600 743 457 - - -
C (1,000) 571 429 686 114 - - - -

Required:
(i) Calculate the payback period for each project. (04-Marks)
(ii) Calculate accounting rate of return (ARR) for each project. (07-Marks)
(iii) Rank the projects according to payback period and ARR. (03-Marks)
(b) Target Industries is also considering to invest in a manufacturing project that would have
a five-year life span. In each year of operation, 80,000 units would be produced and sold. The
contribution per unit, based on current price, is Rs.40. It is expected that the inflation rate will be
10% in each of the next operating years.
The company’s cost of capital / nominal rate is 15%.
 Required:
Calculate net present value (NPV) of the manufacturing project. (08-Marks)
3. NPV (ICMAP February 2014 Q4)
Your company is trying to decide whether to outsource its packing operations or continue to do
it in-house. The current packing machine would not do anymore; it either has to be sold or
thoroughly fixed up. Following two alternatives are available for packing operations:
• Annual in-house packing (excluding depreciation) costs are estimated to be Rs.40 million.
• Outsourcing the packing will cost Rs.50 million per year.
Other details about the two alternatives are as under:
• The company's tax rate is 34%.
• The tax written down value (WDV) of the machine is Rs.30 million, but its market value is
Rs.10 million only.
Doing the packing in-house requires an investment of Rs.20 million to fix up the existing packing
machine. For tax purposes this amount will be added in WDV and depreciated annually at the rate
of 10% of WDV. Given this investment, the machine will be good for another five years but have
no salvage value after 5 years. No tax depreciation will be allowed in year-5 and WDV at the end
of year-4 will be allowed as tax loss on disposal.
The relevant discount rate is 12%.
Required:
(a) Calculate Net Present Value (NPV) for the following options:
(i) In-house packing. (14-Marks)
(ii) Outsourcing. (04-Marks)
(b) (i) Advise better option and briefly state reasons thereof. (01-Marks)
(ii) Briefly state other factors that should be considered while opting best option. (01-Marks)

4. Payback Period (PIPFA Winter 2008 Q1-d)

The company has invested Rs. 150,000 in a business. Its expected profit is as under:
Rs.
2005 40,000
2006 50,000
2007 60,000
2008 70,000
2009 80,000
What is the Payback Period of the Project? (05-Marks)