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Tutorial Week 4

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giang
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8 views

Tutorial Week 4

Tutorial

Uploaded by

giang
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Q1 .

Project A and project B both are competing project with a good


potential from the future returns point of view. Both the projects require
an initial investment outlay of $ 50000 each and are expected to generate
net cash flows (after tax and before depreciation) as under.
End of Project A Cashflow Project B Cashflow (In
year (In $) $)
1 25,000 10,000
2 15,000 12,000
3 10,000 18,000
4 NIL 25,000
5 12,000 8000
6 6000 4000
The cost of capital of the company is 10% per annum. The followings are
the present value factors at 10% per annum.
Required
You are required to calculate the NPV for both the project proposals and
suggest which project should be accepted with the help of valid
justifications.
Solution

Ye Project Work Out NPV - A Project Work Out NPV -B


ar Cash Cash
Flow - A Flow -
B
0 I0 (50000) (50000)
+ +
1 25000 25000 22725 1000 10000 9090
( 1+ 0.1 ) 0 ( 1+ 0.1 )
2 15000 15000 12390 1200 12000 9912
¿¿ 0 ¿¿
3 10000 10000 7510 1800 18 000 13518
¿¿ 0 ¿¿
4 NIL 000 NIL 2500 25 000 17075
¿¿ 0 ¿¿
5 12000 12000 7452 8000 8 000 4968
¿¿ ¿¿
6 6000 6000 3384 4000 4000 2256
¿¿ ¿¿
Total 53461 Total 56819

NPV = -50000 NPV = -50000


+ +56819
53461

NPV= 3461 NPV= 6819


Suggestion: Since the Net present value of project B is higher
than project A therefore project B is financially preferable hence
project B should be acceptable.

Q2
ABC company is considering the investment in a Project requiring
an initial investment outlay of USD 160,000. The project is
expected to generate cash inflows of USD 40,000 per annum, over
a period of 5 years.
Required
You are required to calculate the internal rate of return for the
project.
Solution
Since the cash inflows are uniform over the life span of the
project, the approximate idea of IRR can be had by finding out the
present value factors as follows.
PVF of investment outlay = Initial Investment Outlay /Annual Cash
Inflow
PVF of initial outlay = 160,000/ 40,000 = 4
On locating this factor 4 in the annuity table across the line of
five years we find that the closest. PV factors to the above factor
4 and the corresponding discount rate in the relevant column are
as follows
PVF Discount
rate
4.212 6%
3.993 8%
Hence the approximate IRR is 8% however the actual rate of
return is slightly lower than 8% which can be ascertained by
using the interpolation technique as follows
IRR= D1+[{(C1-I)/(C1-C2)} * (D2-D1)]
IRR = 6%+[{(4.212-4)/(2.212-3.993)} *(8%-6%)]
IRR = 6% +(0.212/0.219)*2%
IRR = 6% + 1.94%
IRR =7.94%
Q3. Case of uneven cash flows
Leela Ltd is considering investing in a project which demands a cash outlay
(initial investment of $ 70000. The rate of discount is 10 % The project is
expected to generate a cashflow for the coming 6 years as follows

YEA CASH INFLOWS


R in $
1 10000
2 12000
3 17000
4 20000
5 23000
6 20000

Kindly suggest the Rate of IRR and advise whether to invest in this project or
not.

Solution
Since the cash inflows are uneven over the life span of the
project, the approximate idea of IRR can be had by finding out the
present value factors as follows.
PVF of investment outlay (I) = Initial Investment Outlay /Average
Cash Inflow
Average Cash Inflow (ACF) =
10000+12000+17000+20000+23000+20000/6 =17000
PVF of initial outlay = 70000/ 17000 = 4.1176
On locating this factor 4.1176 in the annuity table across the line
of five years we find that the closest. PV factors to the above
factor 4 and the corresponding discount rate in the relevant
column are as follows
PVF Discount
rate
C1 4.231 D1 11%
C2 4.111 D2 12%
Hence the approximate IRR is 8% however the actual rate of
return is slightly lower than 8% which can be ascertained by
using the interpolation technique as follows
IRR= D1+[{(C1-I)/(C1-C2)} * (D2-D1)]
IRR = 11%+[{(4.231-4.1176)/( 4.231-4.111)} *(12%-11%)]
IRR = 11% +(0.1134/0.120)*1%
IRR = 11% + 0.945%
IRR =11.945%
The approximate IRR is 12% however the Discount rate of return
is slightly lower i.e 10% which Indicates that investing in this
project is a good decision as IRR > Discount rate.

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