CAPITAL BUDGET ANSWER FOR QUESTIONS 1 TO 3

QUESTIONS 01; ANSWER

TABLE FOR MACHINE A

YEARS CASH FLOWS DISCOUNT DISOUNT CASH CASH FLOW CUMULATIVE

FACTORS FLOW DISCOUTING DISCOUNTING
CASH FLOW
0 (14,000,000) 1.0000 (14,000,000) (14,000,000) (14,000,000)
1 5,000,000 0.8929 (9,000,000) 4,464,500 (9,535,500)
2 5,000,000 0.7972 (4,000,000) 3,986,000 (5,549,500)
3 5,000,000 0.7118 1,000,000 3,559,000 (1,990,500)
4 5,000,000 0.6355 6,000,000 3,177,500 1,187,000

A) SOLUTION (payback period for discount)

PBP= No of year before recover + un recover cost of start/ cash flow

No of year=2. Un recover cost of start=4,000,000. Cashflow=5,000,000

PBP=2+4,OOO,000÷5,000,000

PBP= 2+0.8

PBP=2.8 Years≈3 years

Alternative

PBP=Initial cost÷ cash flow

PBP=14,000,000÷5,000,000

PBP=2.8 Years

B) SOLUTION (Net present value)

TABLE FOR MACHINE A

YEARS CASH FLOWS DISCOUNT CASH FLOW CUMULATIVE

FACTORS DISCOUTING DISCOUNTING
CASH FLOW
0 (14,000,000) 1.0000 (14,000,000) (14,000,000)
1 5,000,000 0.8929 4,464,500 (9,535,500)
2 5,000,000 0.7972 3,986,000 (5,549,500)
3 5,000,000 0.7118 3,559,000 (1,990,500)
4 5,000,000 0.6355 3,177,500 1,187,000

NET PRESENT VALUE FOR MACHINE A IS 1,187,000

 TABLE FOR MACHINE B

YEARS CASH FLOWS DISCOUNT DISOUNT CASH CASH FLOW CUMULATIVE

FACTORS FLOW DISCOUTING DISCOUNTING
CASH FLOW
0 (14,000,000) 1.0000 (14,000,000) (14,000,000) (14,000,000)
1 8,0000,0000 0.8929 (6,000,000) 7,143,200 (6,856,800)
2 6,000,000 0.7972 0 4,783,200 (2,073,600)
3 4,000,000 0.7118 4,000,000 2,847,200 7,736,00
4 2,000,000 0.6355 6,000,000 1,271,000 2,044,600

A) SOLUTION (payback period for discount)

PBP= No of year before recover + un recover cost of start/ cash flow

No of year=2. Un recover cost of start=6,000,000. Cashflow=6,000,000

PBP=2+6,OOO,000÷,000,000

PBP=2+1

PBP=3 years

B) SOLUTION (Net present value)

TABLE FOR MACHINE B

YEARS CASH FLOWS DISCOUNT DISOUNT CASH CASH FLOW CUMULATIVE

FACTORS FLOW DISCOUTING DISCOUNTING
CASH FLOW
0 (14,000,000) 1.0000 (14,000,000) (14,000,000) (14,000,000)
1 8,0000,0000 0.8929 (6,000,000) 7,143,200 (6,856,800)
2 6,000,000 0.7972 0 4,783,200 (2,073,600)
3 4,000,000 0.7118 4,000,000 2,847,200 7,736,00
4 2,000,000 0.6355 6,000,000 1,271,000 2,044,600

NET PRESENT VALUE FOR MACHINE IS 2,044,600

C) SOLUTION

Machine B should be purchased because have high net present value

QUESTION 2; ANSWER

TABLE FOR COMPUTATION NET PRESENT VALUE FOR ALL PROJECTS

DETAILS PROJECT 1 PROJECT 2 PROJECT 3 PROJECT 4

Investment 480,000,000 360,000,000 270,000,000 450,000,000
required
Present value of 567,270,000 433,400,000 336,140,000 522,970,00
cash flow
NPV=(PV-IC) 87,270,000 73,400,000 66,140,000 72,970,000

A) SOLUTION (To compute profitability of each project)

Profitability index (PI)= Net present value + initial cost÷ initial cost

PI=NPV+CO/CO

TABLE FOR COMPUTE PROFITABILITY INDEX OF EACH PROJECT

DETAILS PROJECT 1”000” PROJECT 2”000” PROJECT 3”000” PROJECT 4”000”

PI=NPV+CO 87,270+480,000 73,400+360,000 66,140+270,000 72,970+450,000
CO 480,000 360,000 270,000 450,000
PI =1.1818 =1.2039 =1.2450 =1.1622

B) SOLUTION
(to ranks projects according to Net present value)

DETAILS NET PRESENT VALUE (NPV) RANKS

PROJECT 1 87,270,000 1
PROJECT 2 73,400,000 2
PROJECT 4 72,970,000 3
PROJECT 3 66,140,000 4

(To ranks project according to profitability index)

DETAILS PROFITABILITY INDEX(IP) RANKS

PROJECT 3 1.2450 1
PROJECT 2 1.2039 2
PROJECT 1 1.1818 3
PROJECT 4 1.1622 4
QUESTION 3; ANSWER

A) SOLUTION

i) To compute the payback period for the equipment

PBP=Initial investment/cash flow

Initial investment=360,000,000

Cash flow= 75,000,000

PBP=360,000,000/75,000,000

PBP=4.8 Years≈5 years

Equipment should not be purchased because is over 4 years that expected by company

ii) To compute the annual rate of return on the equipment

Where required rate of return is 14%

ARR=Average income (after tax)/Average investment*100

Average investment=initial cost+ scrap value/2

Average income=30,000,000

Initial cost=360,000,000

Scrap value=0

Average investment= 360,000,000-0/2

Average investment =180,000,000

ARR=30,000,000/180,000,000*100

ARR=16.67%

Equipment should be purchased