# Experiments in Finance

• […] Calculating the internal rate of return (or IRR) of a project is one of the most popular methods that companies and managers use to determine whether a project is worth investing in. Now that I’ve covered a bit about NPVs and DCFs, it makes sense to go through what IRR is, how to use it, and why it’s not an ideal measurement. […]

Pingback by How to calculate an internal rate of return (IRR), and when not to use it | Experiments in Finance — January 21, 2007 @ 11:20

• I’ve been trying to solve this problem for sometime with no success. I have also attempted using your information (How to calculate NPV) on the website, got close but still didnt get the solution.

here is the question.

A fashion clothing company is considering investing in new machinery to improve its productivity over the next 5 years. You have been given the following information:

Sales are predicted to increase by \$1,500,000 in year 1 and continue at this level.

The new machinery costs \$10 million payable immediately.

It will be depreciated over 5 years on a straight line basis.

All the old machinery can be sold for \$2 million.

The new equipment is more complicated and will cost \$160,000 per year every year to maintain, as against the \$100,000 for the old machines, but other running costs will be reduced by \$120,000.

Finance for the purchase needs to be raised via a loan which requires annual interest payments of \$300,000.

Wages will be reduced by \$100,000 due to increased automation.

At the end of the five years the machinery will have a scrap value of \$2million.

The feasibility study for this project (already completed and paid for) cost \$200,000.

The cost of capital on investment appraisal for this level of risk is 7.5%.

Identify which of these items would be included in an NPV calculation and calculate the NPV. You may ignore tax and inflation.

Comment by Moses Kidane — August 1, 2007 @ 7:36

• an interesting and challenging question for students of finance. kindly provide solution to the question and forward a copy to my email. regards.

Comment by abiodun — October 18, 2007 @ 6:30

• Hi,

Santa Monica Corp is considering the acquisition of a unit in France. Initial outlay = \$4,000,000. It will reinvest all the earnings in the unit. It expects that at the end of 8 years, it will sell the unit for 12 million euros after capital gains taxes are paid. Spot rate of euro = \$1.20. The company has no plans to hedge its exposure to exchange rate risk. The annualized U.S. interest rate = 5%. The annualized interest rate on euros = 7%. Assume that interest rate parity exists. Santa Monica’s cost of capital is 20 %. It plans to use the cash to make the acquisition.
Determine the NPV under these conditions.

Thanks,
Angela

Comment by Angela — October 28, 2007 @ 12:01

• Hey,

Need a little help on this one;

Ferry plc is considering a investment of R\$.2,400,000( fixed Assets 2.000.000 and working capital of 400.000) subsidary is projected to acheive annual sales of R\$1.600.00 and incur cash expenditures of 1.000.000 a year.

Projection states that after 4 years the subsidiary expects relisable value of R\$ 800.000 and projects to sell the rights of the product for R\$500.000.

Tax payable 35% payable in the same year. and Tax allowable depreciation of 25% on a straight line basis on all fixed assets.

Spot is R\$:£ is 5:1

Annual Inflation rate R\$: 5%
Annual Inflation rate £ :3%

cost of capital is 12%

Can anyone help me out on this one?

hope to hear from you,

Thanks, Theo

Comment by Theo Bautista — November 4, 2007 @ 19:41

• When to consider capital gain tax, how to calculate depreciation when an old machinery is replaced by a new one and the old machine has a scrap value. Which books will help me understand the concept of NPV and IRR better with solved examples of professional exams like CA, ICWA, CS etc..

Comment by Mihir Shah — February 23, 2008 @ 1:56

• I need help in this question, I am a little bit confused to which method I will be using and why? Please help.

Explain why strategic investment decisions are both important and difficult. Discuss the alternative approaches to the making of these decisions, identify the method that produces the best decision and justify your choice with a fully reasoned explanation.

Comment by Tony — March 11, 2008 @ 21:46

• Explain why strategic investment decisions are both important and difficult. Discuss the alternative approaches to the making of these decisions, identify the method that produces the best decision and justify your choice with a fully reasoned explanation.

Comment by dana — March 14, 2008 @ 7:37

• I would appreciate your help with regards to this question. Thanks

Explain why strategic investment decisions are both important and difficult. Discuss the alternative approaches to the making of these decisions, identify the method that produces the best decision and justify your choice with a fully reasoned explanation.

Comment by dana — March 14, 2008 @ 7:39

• I want to fuck you

Comment by Mr. Shahal Uddin — June 5, 2008 @ 22:48

• Please explain me on the diffrences between NPV of corporate finance with the NPV of valuation properties.

Comment by nadia — August 18, 2008 @ 17:25

• now students like me have an opportuinity to get first hand information on handling calculations on finanances

Comment by Dauda Pabir Bwala — September 11, 2008 @ 15:59

• Its very good and useful website

Comment by Basavaraj — September 29, 2008 @ 4:46

• I have a question and I hope not to confuse in the proccess of explaining it.

I am taking a Financial Management class and my instructor is not very helpful. (to put it nicely)

The biggest problem is he is not explaining things very well. I don’t understand how a equation for NPV can return a correct number in the calculator and not in the excel spreadsheet. For example:

The chapter is chapter 11 the problem is 11-7. A firm with a 14 percent WACC is evaluating two projects for this year’s capital budget. After-tax cash inflows, including depreciation, are as follows:

Project A: Year0=-6000 Year1=2000 Year2=2000 Year3=2000 Year4=2000 Year5=2000

Project B: Year0=-18000 Year1=5600 Year2=5600 Year3=5600 Year4=5600 Year5=5600

Calculate NPV.

My instructor gets 866.16 for project A using the caculator.

I get 759.79 using the NPV formula in excel.

My instructor gets 1255.25 for project A using the caculator.

I get 1074.78 using the NPV formula in excel.

Why are my answers so different? Am I doing something wrong?

Comment by LLL — October 3, 2008 @ 15:03

• @LLL – The difference between what your instructor is calculating and what you’re getting has to do with timing the cash flows. Your instructor is assuming that “now” is Year 0, so s/he is calculating NPV based on a WACC of 14% and the 4 cash flows from Year 1-Year 5. Then s/he’s subtracting the outlay in Year 0 (so \$6K in project A and \$18K in project B) from the NPV figure. NPV has to do with “moving” cash flows between time periods. If you set up your excel by putting in each year’s cash flows in cells A1 through F1 and do an NPV calculation like this:

=NPV(14%,B1:F1)

and then subtract off A1, you’ll get the same figures your instructor is getting.

The way you’re calculating NPV, you’re assuming that Year 0 isn’t “now” but a year in the future. Just depends on how you or the problem is defined. Usually Year 0 reflects “now” so your instructor’s answers are probably what most people would be looking for and calculating.

Comment by ricemutt — October 3, 2008 @ 15:30

• please i need the mathematical formula for calculating NPV and IRR. thanks

Comment by lydia — October 12, 2008 @ 13:56

• how do you do this problem:

Doughboy Bakery would like to buy a new machine for putting icing and other toppings on pastries. These are now put on by hand. The machine that the bakery is considering costs \$90,000 new. It would last the bakery for six years but would require a \$7,500 overhaul at the end of the third year. After six years, the machine could be sold for \$6,000. It would be fully depreciated over the six year life using straight-line depreciation for tax purposes.
The bakery estimates that it will cost \$14,000 per year to operate the new machine and that there will be a working capital requirement of \$20,000 that will be returned when the equipment is sold. The present manual method of putting toppings on the pastries costs \$35,000 per year. In addition to reducing operating costs, the new machine will allow the bakery to increase its production of pastries by 5,000 packages per year. The bakery realizes a contribution margin of \$0.60 per package. The bakery requires a 16% return on all investments in equipment. And the effective income tax rate is 30%.
1. What are the net annual cash inflows that will be provided by the new machine?
2. Compute the new machine’s net present value.

Comment by michelle — October 13, 2008 @ 12:34

• Discounting Cash Flows
Cafe Case Study

• Suppose you are thinking about starting a small café or canteen inside a university campus.
• You make a simple Feasibility Report showing the Estimated Initial Investment and the Forecasted Cash Flows for the first Year (based on expected Cash Receipts from sales and Cash Payments for expenses).
• The Key Financial Data is as follows:
– Initial Investment = Rs 100,000
– Forecasted Cash Receipts (end Year 1) = Rs 200,000
– Forecasted Cash Payments (end Year 1) = Rs 50,000
– Forecasted Future Investment (end Year 1)=Rs30,000
– Periodic Interest Rate (Opportunity Cost) = 10% p.a.

Calculate the Net Present Value for this business.
thanx,
ZAKIR KHAN MARWAT BBA
COMSATS UNIVERSITY

Comment by zakir khan — October 14, 2008 @ 1:19

• Hi

If looking on a new investment that is a replacement for equipment that a company already have, for exampel a new more efficiant machine, and the old machine can be sold for a some cash. Do I take the cashflow from selling the old machine into account when performing a incremental cash flow analysis on the new pice of machinery?

Kind regards Peter

Comment by Peter Eklof — October 17, 2008 @ 13:39

• please i need an ans to the question posted by moses kidane on the 1st of aug 2007.

being trying to solve it just not getting thru. thanks

Comment by mike — October 17, 2008 @ 19:32

• I’ve been trying to solve this problem for sometime with no success. I have tried using your solution methods,still did not get to the answer.

Pls can u help?

FGM plc, a motor manufacturer, is considering the launch of a new range of custom-built sports cars, incorporating a revolutionary design of automatic gearbox, which is claimed to be ultra fuel-efficient. The project is code-named project X.

The new key features of the gearbox have been patented by the inventor but he has approached FGM with a view to selling the patent rights. However he requires an early response before he offers the patent to competitors. The patent would cost £5 million.

Profit estimates have been prepared based on market research and these are detailed below. The time-scale to launch the new range on the market would be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

If the project goes ahead, a new factory needs to be built, costing £2million plus £6 million for manufacturing equipment. In addition the land site for the factory is expected to cost £3 million.

The company’s depreciation policy is to use the straight-line method with residual values assumed to be zero. Land costs are not depreciated. Patent costs are amortised over the expected useful life of the patent, which in this case is 10 years.

The new range has an expected market life of 10 years. The useful life of both the factory and the equipment is also 10 years.

The project will be financed by a bank loan, which will incur interest of £300,000 per annum, payable in arrears at the end of each year, with the loan being repaid after 10 years.

The working capital for the project is estimated to be £1.2 million starting from the year of the product launch.

Profit Estimates

The profits shown below are after charging depreciation, interest on the bank loan.

Year Profit/(Loss) £m
1 (2.3)
2 1.5
3 6.0
4 8.0
5 10.0
6 10.0
7 8.0
8 6.0
9 4.0
10 2.0

The project detailed above is code-named Project X.

There is also an alternative proposal, code-named Project Y.

This project involves using gear-box technology, already created internally, from the company’s own engineering laboratory. This technology is estimated to have cost £3 million. However this technology is less advanced and therefore production could take place in the existing factory by putting on a night shift. Also only £4 million would need to be spent on equipment, the bank loan would be unnecessary and the working capital requirement would reduce to £0.8 million.

As for Project X, the time-scale to launch the new range on the market under Project Y would also be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

The profit estimates for Project Y after charging depreciation on the new equipment, are estimated as follows:

Year Profit/(Loss) £m
1 2.1
2 3.6
3 3.6
4 3.6
5 2.6
6 2.6
7 2.6
8 1.6
9 1.6
10 0.6

The company’s money cost of capital is 15% p.a. Of this cost, 3% comprises allowance for inflation.

All cash figures are expressed in today’s money i.e. exclusive of inflation.

Required:

Using the information presented above, prepare a Report for the Directors.

The Report should include:

– Recommendation as to which (if any) of the projects should be implemented. The recommendation must be logically argued and supported with both quantitative and qualitative factors

– Identification of any areas where further work or information is required and clear explanation of why such work or information is necessary.

– Explanation of how risk has been taken into account in arriving at your recommendation.

– Identification and critical evaluation of any of the techniques you have used or have recommended using

– Explanation and justification of all adjustments made to profit estimates to arrive at cash flow estimates

– How “real options” have been taken into account

– How inflation has been taken into account
(60% weighting)

-Quantitative analysis in support of the Report and recommendations

(40% weighting)

Comment by Angela Brown — October 19, 2008 @ 13:55

• I applaud your initiative in this website.I often come to read and try to solve some of the questions as training for myself.For better understanding,Kindly also send me a solution to the question from Angela Brown on the 17th of October 2008 regarding FGM Plc.
Regards.

Comment by Max Davies — October 22, 2008 @ 17:49

• Hi, please, can you help me… I need to know how to estimate the labor cost of a bakery that is rigth now starting, Ihave the cost of menu items, the food cost %, but I don´t know how to calculate the labor.
Thanks

Comment by alex raijel — October 23, 2008 @ 14:51

• I’ve been trying to solve this problem for sometime with no success. I have tried using your solution methods,still did not get to the answer.

Pls can u help?

FGM plc, a motor manufacturer, is considering the launch of a new range of custom-built sports cars, incorporating a revolutionary design of automatic gearbox, which is claimed to be ultra fuel-efficient. The project is code-named project X.

The new key features of the gearbox have been patented by the inventor but he has approached FGM with a view to selling the patent rights. However he requires an early response before he offers the patent to competitors. The patent would cost £5 million.

Profit estimates have been prepared based on market research and these are detailed below. The time-scale to launch the new range on the market would be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

If the project goes ahead, a new factory needs to be built, costing £2million plus £6 million for manufacturing equipment. In addition the land site for the factory is expected to cost £3 million.

The company’s depreciation policy is to use the straight-line method with residual values assumed to be zero. Land costs are not depreciated. Patent costs are amortised over the expected useful life of the patent, which in this case is 10 years.

The new range has an expected market life of 10 years. The useful life of both the factory and the equipment is also 10 years.

The project will be financed by a bank loan, which will incur interest of £300,000 per annum, payable in arrears at the end of each year, with the loan being repaid after 10 years.

The working capital for the project is estimated to be £1.2 million starting from the year of the product launch.

Profit Estimates

The profits shown below are after charging depreciation, interest on the bank loan.

Year Profit/(Loss) £m
1 (2.3)
2 1.5
3 6.0
4 8.0
5 10.0
6 10.0
7 8.0
8 6.0
9 4.0
10 2.0

The project detailed above is code-named Project X.

There is also an alternative proposal, code-named Project Y.

This project involves using gear-box technology, already created internally, from the company’s own engineering laboratory. This technology is estimated to have cost £3 million. However this technology is less advanced and therefore production could take place in the existing factory by putting on a night shift. Also only £4 million would need to be spent on equipment, the bank loan would be unnecessary and the working capital requirement would reduce to £0.8 million.

As for Project X, the time-scale to launch the new range on the market under Project Y would also be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

The profit estimates for Project Y after charging depreciation on the new equipment, are estimated as follows:

Year Profit/(Loss) £m
1 2.1
2 3.6
3 3.6
4 3.6
5 2.6
6 2.6
7 2.6
8 1.6
9 1.6
10 0.6

The company’s money cost of capital is 15% p.a. Of this cost, 3% comprises allowance for inflation.

All cash figures are expressed in today’s money i.e. exclusive of inflation.

Required:

Using the information presented above, prepare a Report for the Directors.

The Report should include:

– Recommendation as to which (if any) of the projects should be implemented. The recommendation must be logically argued and supported with both quantitative and qualitative factors

– Identification of any areas where further work or information is required and clear explanation of why such work or information is necessary.

– Explanation of how risk has been taken into account in arriving at your recommendation.

– Identification and critical evaluation of any of the techniques you have used or have recommended using

– Explanation and justification of all adjustments made to profit estimates to arrive at cash flow estimates

– How “real options” have been taken into account

– How inflation has been taken into account
(60% weighting)

-Quantitative analysis in support of the Report and recommendations

(40% weighting)

Comment by Mike Kamali — October 29, 2008 @ 6:15

• Hi,
Could you help me solve the following questions…
a)A machine will cost 100,000 dollars and will provide an annual cashflow of 30,000 for 6 years,the cost of capital is 15% and the tax bracket is 30%.The salvage value is after 6 years is 10,000,depreciation is a straight line
1.Calculate the net present value of the machine acquisition.
2. The internal rate of return
Should the machine be purchased?
b)A firm is considering 2 mutually exclusive projects
Project Yr1 Yr2 Yr3
A 25,000 5,000 25,000
B 28,000 12,672 12,672
a)Time cost of the capital is 12%.Compute the NPV and IRR at each point.
b)Why the project should be undertaken and why.

Comment by Jimmy Sitati — November 3, 2008 @ 0:26

• I’ve been trying to solve this problem for sometime with no success. I have tried using your solution methods,still did not get to the answer.

Pls can u help?

FGM plc, a motor manufacturer, is considering the launch of a new range of custom-built sports cars, incorporating a revolutionary design of automatic gearbox, which is claimed to be ultra fuel-efficient. The project is code-named project X.

The new key features of the gearbox have been patented by the inventor but he has approached FGM with a view to selling the patent rights. However he requires an early response before he offers the patent to competitors. The patent would cost £5 million.

Profit estimates have been prepared based on market research and these are detailed below. The time-scale to launch the new range on the market would be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

If the project goes ahead, a new factory needs to be built, costing £2million plus £6 million for manufacturing equipment. In addition the land site for the factory is expected to cost £3 million.

The company’s depreciation policy is to use the straight-line method with residual values assumed to be zero. Land costs are not depreciated. Patent costs are amortised over the expected useful life of the patent, which in this case is 10 years.

The new range has an expected market life of 10 years. The useful life of both the factory and the equipment is also 10 years.

The project will be financed by a bank loan, which will incur interest of £300,000 per annum, payable in arrears at the end of each year, with the loan being repaid after 10 years.

The working capital for the project is estimated to be £1.2 million starting from the year of the product launch.

Profit Estimates

The profits shown below are after charging depreciation, interest on the bank loan.

Year Profit/(Loss) £m
1 (2.3)
2 1.5
3 6.0
4 8.0
5 10.0
6 10.0
7 8.0
8 6.0
9 4.0
10 2.0

The project detailed above is code-named Project X.

There is also an alternative proposal, code-named Project Y.

This project involves using gear-box technology, already created internally, from the company’s own engineering laboratory. This technology is estimated to have cost £3 million. However this technology is less advanced and therefore production could take place in the existing factory by putting on a night shift. Also only £4 million would need to be spent on equipment, the bank loan would be unnecessary and the working capital requirement would reduce to £0.8 million.

As for Project X, the time-scale to launch the new range on the market under Project Y would also be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

The profit estimates for Project Y after charging depreciation on the new equipment, are estimated as follows:

Year Profit/(Loss) £m
1 2.1
2 3.6
3 3.6
4 3.6
5 2.6
6 2.6
7 2.6
8 1.6
9 1.6
10 0.6

The company’s money cost of capital is 15% p.a. Of this cost, 3% comprises allowance for inflation.

All cash figures are expressed in today’s money i.e. exclusive of inflation.

Required:

Using the information presented above, prepare a Report for the Directors.

The Report should include:

– Recommendation as to which (if any) of the projects should be implemented. The recommendation must be logically argued and supported with both quantitative and qualitative factors

– Identification of any areas where further work or information is required and clear explanation of why such work or information is necessary.

– Explanation of how risk has been taken into account in arriving at your recommendation.

– Identification and critical evaluation of any of the techniques you have used or have recommended using

– Explanation and justification of all adjustments made to profit estimates to arrive at cash flow estimates

– How “real options” have been taken into account

– How inflation has been taken into account
(60% weighting)

-Quantitative analysis in support of the Report and recommendations

(40% weighting)

Comment by Praise Anya — November 3, 2008 @ 16:01

• please if anyone knows how to do this let me know

Chatman Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for \$787,200 is estimated to result in \$262,400 in annual pretax cost savings. The press falls in the MACRS five-year class (MACRS Table), and it will have a salvage value at the end of the project of \$114,800. The press also requires an initial investment in spare parts inventory of \$32,800, along with an additional \$4,920 in inventory for each succeeding year of the project. If the shop’s tax rate is 30 percent and its discount rate is 12 percent, the NPV for the project is \$ and Chatman buy and install the machine press. (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places, e.g. 32.16.)

Comment by chris — November 3, 2008 @ 17:36

• this is the cost-cutting proposal and i have to find the NPV i know that should not buy the machine because the NPV is negative but i dont know what the NPV is someone help

Chatman Machine Shop is considering a four-year project to improve its production efficiency. Buying a new machine press for \$787,200 is estimated to result in \$262,400 in annual pretax cost savings. The press falls in the MACRS five-year class (MACRS Table), and it will have a salvage value at the end of the project of \$114,800. The press also requires an initial investment in spare parts inventory of \$32,800, along with an additional \$4,920 in inventory for each succeeding year of the project. If the shop’s tax rate is 30 percent and its discount rate is 12 percent, the NPV for the project is \$ and Chatman buy and install the machine press. (Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places, e.g. 32.16.)

Comment by chris — November 3, 2008 @ 17:38

• Thank you for your help on this site.Please i have a question similar to Angela Brown’s question.Could you please send me the answer to her question.Thanks

Comment by PETER PAUL — November 4, 2008 @ 14:53

• I’ve been trying to solve this problem for sometime with no success. I have tried using your solution methods,still did not get to the answer.

Pls can u help?

FGM plc, a motor manufacturer, is considering the launch of a new range of custom-built sports cars, incorporating a revolutionary design of automatic gearbox, which is claimed to be ultra fuel-efficient. The project is code-named project X.

The new key features of the gearbox have been patented by the inventor but he has approached FGM with a view to selling the patent rights. However he requires an early response before he offers the patent to competitors. The patent would cost £5 million.

Profit estimates have been prepared based on market research and these are detailed below. The time-scale to launch the new range on the market would be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

If the project goes ahead, a new factory needs to be built, costing £2million plus £6 million for manufacturing equipment. In addition the land site for the factory is expected to cost £3 million.

The company’s depreciation policy is to use the straight-line method with residual values assumed to be zero. Land costs are not depreciated. Patent costs are amortised over the expected useful life of the patent, which in this case is 10 years.

The new range has an expected market life of 10 years. The useful life of both the factory and the equipment is also 10 years.

The project will be financed by a bank loan, which will incur interest of £300,000 per annum, payable in arrears at the end of each year, with the loan being repaid after 10 years.

The working capital for the project is estimated to be £1.2 million starting from the year of the product launch.

Profit Estimates

The profits shown below are after charging depreciation, interest on the bank loan.

Year Profit/(Loss) £m
1 (2.3)
2 1.5
3 6.0
4 8.0
5 10.0
6 10.0
7 8.0
8 6.0
9 4.0
10 2.0

The project detailed above is code-named Project X.

There is also an alternative proposal, code-named Project Y.

This project involves using gear-box technology, already created internally, from the company’s own engineering laboratory. This technology is estimated to have cost £3 million. However this technology is less advanced and therefore production could take place in the existing factory by putting on a night shift. Also only £4 million would need to be spent on equipment, the bank loan would be unnecessary and the working capital requirement would reduce to £0.8 million.

As for Project X, the time-scale to launch the new range on the market under Project Y would also be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

The profit estimates for Project Y after charging depreciation on the new equipment, are estimated as follows:

Year Profit/(Loss) £m
1 2.1
2 3.6
3 3.6
4 3.6
5 2.6
6 2.6
7 2.6
8 1.6
9 1.6
10 0.6

The company’s money cost of capital is 15% p.a. Of this cost, 3% comprises allowance for inflation.

All cash figures are expressed in today’s money i.e. exclusive of inflation.

Required:

Using the information presented above, prepare a Report for the Directors.

The Report should include:

– Recommendation as to which (if any) of the projects should be implemented. The recommendation must be logically argued and supported with both quantitative and qualitative factors

– Identification of any areas where further work or information is required and clear explanation of why such work or information is necessary.

– Explanation of how risk has been taken into account in arriving at your recommendation.

– Identification and critical evaluation of any of the techniques you have used or have recommended using

– Explanation and justification of all adjustments made to profit estimates to arrive at cash flow estimates

– How “real options” have been taken into account

– How inflation has been taken into account
(60% weighting)

-Quantitative analysis in support of the Report and recommendations

(40% weightin

Comment by vooodooonox — November 9, 2008 @ 21:56

• hi could u please help me out in solving this problem iam unable 2 do it i did something but not giving me any data about

FGM plc, a motor manufacturer, is considering the launch of a new range of custom-built sports cars, incorporating a revolutionary design of automatic gearbox, which is claimed to be ultra fuel-efficient. The project is code-named project X.

The new key features of the gearbox have been patented by the inventor but he has approached FGM with a view to selling the patent rights. However he requires an early response before he offers the patent to competitors. The patent would cost £5 million.

Profit estimates have been prepared based on market research and these are detailed below. The time-scale to launch the new range on the market would be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

If the project goes ahead, a new factory needs to be built, costing £2million plus £6 million for manufacturing equipment. In addition the land site for the factory is expected to cost £3 million.

The company’s depreciation policy is to use the straight-line method with residual values assumed to be zero. Land costs are not depreciated. Patent costs are amortised over the expected useful life of the patent, which in this case is 10 years.

The new range has an expected market life of 10 years. The useful life of both the factory and the equipment is also 10 years.

The project will be financed by a bank loan, which will incur interest of £300,000 per annum, payable in arrears at the end of each year, with the loan being repaid after 10 years.

The working capital for the project is estimated to be £1.2 million starting from the year of the product launch.

Profit Estimates

The profits shown below are after charging depreciation, interest on the bank loan.

Year Profit/(Loss) £m
1 (2.3)
2 1.5
3 6.0
4 8.0
5 10.0
6 10.0
7 8.0
8 6.0
9 4.0
10 2.0

The project detailed above is code-named Project X.

There is also an alternative proposal, code-named Project Y.

This project involves using gear-box technology, already created internally, from the company’s own engineering laboratory. This technology is estimated to have cost £3 million. However this technology is less advanced and therefore production could take place in the existing factory by putting on a night shift. Also only £4 million would need to be spent on equipment, the bank loan would be unnecessary and the working capital requirement would reduce to £0.8 million.

As for Project X, the time-scale to launch the new range on the market under Project Y would also be 2 years from any go-ahead date, with the required manufacturing investment decision having to be made 1 year from now.

The profit estimates for Project Y after charging depreciation on the new equipment, are estimated as follows:

Year Profit/(Loss) £m
1 2.1
2 3.6
3 3.6
4 3.6
5 2.6
6 2.6
7 2.6
8 1.6
9 1.6
10 0.6

The company’s money cost of capital is 15% p.a. Of this cost, 3% comprises allowance for inflation.

All cash figures are expressed in today’s money i.e. exclusive of inflation.

Required:

Using the information presented above, prepare a Report for the Directors.

The Report should include:

– Recommendation as to which (if any) of the projects should be implemented. The recommendation must be logically argued and supported with both quantitative and qualitative factors

– Identification of any areas where further work or information is required and clear explanation of why such work or information is necessary.

– Explanation of how risk has been taken into account in arriving at your recommendation.

– Identification and critical evaluation of any of the techniques you have used or have recommended using

– Explanation and justification of all adjustments made to profit estimates to arrive at cash flow estimates

– How “real options” have been taken into account

– How inflation has been taken into account
(60% weighting)

– Quantitative analysis in support of the Report and recommendations

(40% weighting)

Comment by bachi — November 11, 2008 @ 4:21

• I have a problem with a financial accounting problem. I am clueless about it. can you help me please. here goes:
you are considering the purchase ofa speech recognition dictation system. Firm A requires an upfront payment of \$250.00 and an annual maintenance payment of \$37,000 at the time of the contract. thereafter maintenance payments of \$37,000 are made at the beginningog each anniversary year for a total of 5 maintenance payments inculding the initial payment made at the time of purchase.

the other firm Firm B requires an up-front payment of \$325,000 and an annual maintenance payment of \$7,000 at the time of contract signing. Thereafter maintenance payments of \$7,000 are made at the beginningof each anniverasy yaer fora total of 5 maintenance payments inculding the initial payment made at the time of purchase.

Installation and oather initial set up cost are estimated at \$50.000 for either product. Both vendors quoted on iste training will cost \$5,000 and will take place at time of implementation. No ongoing trraining cost was noted n eaither proposal becuse the \$5,000 inludes training a trainer.

there is an average savings at year’s end is \$105,000 per year. CFO will earn 5% interest on the hospital’s funds. He will not consider any project that yields less than a 20% return. useful life of the acquisition is 5 years.

a. claculate the net present value of each option show calculations
b. calculate the payback of each option show calculation
c. calculate the average rate of return of each option show calculations

Comment by evworth charles — November 23, 2008 @ 17:26

• Hello
Could You help me solve the following problem, please

Calculate the NPV of the following investment:
My company is evaluating the investment in a new plant, which will generate a 15,000000 US\$ cash return each year for in coming 4 years ( from year1-to year 4).The operating costs will be equal to 5,000000 US\$ each year ( from year1-to year 4), plus an initial investment of 35,000000 US\$ in year 0. In year 4 the plant is forecasted to be sold for 15.000000 US\$.
Please, calculate NPV of the investment using 10% as a discount rate.
Do I have to make this investment? Why?
Thank You very much! Best regards!

Comment by Azim — November 25, 2008 @ 2:17

• Could You help me in solving this following problem, please

Comment by Azim — November 25, 2008 @ 4:42

• Can you help me solve this problem pls.

Alpha Bank plans on offering a considerable two-year loan. Although this loan is not long-term oriented, it is potentially of significant value to the bank. As the bank’s Chief Risk Officer, you disagree with the Chief Finance Officer (CFO)’s view on this; in particular, you disagree as to whether this loan creates value for the bank, given its riskiness, and whether the risk management department can be allocated a % of the anticipated profits from this loan. The amount to be lent is £100M for 2 years.

Specifically, the terms of the loan are:

• 2-year to maturity loan of £100M with interest paid every year and principal of £100M at maturity
• Equity funding = 6%
• Cost of equity = 15%
• Interbank funding = 94%
• Corporate tax rate = 25%
• Libor = 10%
• Loan rate = 14%
• Probability of Default (PD) Year 1 = 0%
• Probability of Default Year (PD) 2 = 4%
• Recovery in case of default = 20% (or equivalently Loss Given Default = 80%)

Today, the issue is mainly in two-fold:
a) Does this loan create value for the bank given its risk characteristics?
b) Assuming that everything performed according to plan in the first year, then how much profit must be accrued? Given a few points of disagreement between you and the CFO, the Chief Executive has asked you both to present reports elaborating on your arguments.

Write a report of 2,000 based on the above data outlining your recommendations to the Chief Executive Officer.

Comment by Anne — December 14, 2008 @ 12:42

• Assume the risk-adjusted cost of capital is 10% and its tax rate is 40%. Compute the net present value (NPV) for each warehouse proposal. Include the cash flows from salvage value and the tax benefits of depreciation (assume 5-year straight-line). Incorporate the research data and graphs and charts into my presentation to support for my recommendations.Proposal 1 Proposal 2
New Warehouse Location North Warehouse West Warehouse
Estimated first year revenue increase \$650,000 \$900,000
Estimated annual revenue growth 7% 8%
Estimated variable costs % 45% 55%
Marginal tax rate 40% 40%
Estimated annual fixed costs \$100,000 \$120,000
Investment in facility \$1,500,000 \$1,700,000
One-time advertising in year 0 \$140,000 \$150,000
Estimated salvage value in year 6 \$125,000 \$120,000

Comment by Timothy — December 19, 2008 @ 18:52

• i want to know how to calculate net present value

Comment by evulobi onyedikachi — December 29, 2008 @ 7:25

• i need the solution of the same problem urgently.

Comment by Diya — January 6, 2009 @ 10:08

• I’ve been asked to do the calculations and till the dead line have no chances of asking more questions regarding it. I therefore hope i would get help from you.

Need to calculate the NPV for two cases when a company has (company X) 13% adjusted risk rate and (company Y) 15%.
The first one uses the current technology and the other one installes new.

Cost of capital is 12% and risk-free rate of interest 9%.

initiall investment in case X is 2700000 and the case Y 2100000.

Cash flows are:
X
470000
610000
950000
970000
1500000
Y
380000
700000
800000
600000
1200000

I would appreciate if you could help me on the issue.

Comment by Urim — January 19, 2009 @ 6:10

• Need help to solve this problem and understand how to tackle. Please let me know how soon can you provide an answer.

Manufacture of a printed circuit board product is to last 2 years. The work requires moving a printed circuit board mounted with electronic components in an assembly-line fashion. Two solution are proposed: A fixed belt conveyor costing \$75000 is estimated to have an annual operating cost of \$20000 and \$15000 salvage value at the end of the second year. An alternate choice is mobile equipment costing \$30000 and its estimated operating cost is 70000 annually. Salvage value of the mobile equipment is \$10000 at the end of 2 years. These alternatives have a longer physical life than the project life.
a) Sketch the cash flow diagrams. Find the preferred method for an interest rate of 10%. Find the annual cost of both methods.
b) Repeat part (a) for 20%. Discuss the effects of raising the interest rate.

Comment by Masoud — February 13, 2009 @ 13:06

• Hi there- trying to solve this problem – the backwards of NPV.

This is a sale that gets a certain sum up front and additional annual payments depending on contract. Depending on changing startup price, I need to calculate the annual future sums.
i.e.

Startup Price 35000
Renewal Price 15000
Length of Contract 5
Discount Rate 10%
NPV \$82,547.98

No if I change the Startup price, how can I calculate the Renewal price?

Comment by Catherine King — February 17, 2009 @ 12:50

• Hi

I please need some help to solve this problem: a pharmaceutical company is considering developing a new drug, which if successful would give the company exclusive rights to produce and market the product. if successful, the firm will acquire a patent that gives it the xclusive right to produce the drug for the following 17years; assume that the corresponding 17 year Treasury-bond rate is 6%.

Financial analysis of the projects leads to the conclusion that the cost of developing the drug is \$2.9 billion, while the investment is expected to produce a payoff equal to \$3.4billion.

1-What is the projects’s NPV?

2-How confident should shareholders be as to indicated developement cost of an expected payoff from the firm’s R&D expenditure on this drug?

Comment by ameliesom — March 12, 2009 @ 10:40

• nice one

Comment by kiisi — March 17, 2009 @ 8:15

ukooltd is considering an investment proposal which will yield a contribution margin of sh600,000 every year.the project will cost sh200,000,has a usefull life of 10 years and a neglible salvage value.the co.uses a straight-line depreciation method and is in 50%tax bracket.the opportunity cost of capital is 12%.
required:
determine the NPV if
1.a normal annual repair of sh 20,000 will be required after being in operation for 5 years .

2.the project requires an overhaul costing of sh 200,000at the end of the sixth year.

Comment by zack orguba — March 18, 2009 @ 0:05

• How can I calculate NPV if I have WACC, capital, year and average return per year?

With thanks

Comment by Barkat Ullah — April 3, 2009 @ 6:34

• Yenki Ltd. is considering two mutually exclusive projects A and B. Project A costs
Rs. 30,000 and Project B Rs. 36,000. The

NPV probability distribution for each project is
as given below :
Project A Project B
NPV Estimate Probability NPV Estimate Probability
Rs. 3,000 0.1 Rs. 3,000 0.2
6,000 0.4 6,000 0.3
12,000 0.4 12,000 0.3
15,000 0.1 15,000 0.2
You are required to compute:
i) the expected Net Present Value of Projects A and B.
ii) The risk attached to each project i.e., Standard deviation of each probability distribution.
iii) The Profitability Index of each project.
Which project do you consider more risky and why?

Comment by Sehar — April 21, 2009 @ 6:10

• Yenki Ltd. is considering two mutually exclusive projects A and B. Project A costs
Rs. 30,000 and Project B Rs. 36,000. The

NPV probability distribution for each project is
as given below :
Project A Project B
NPV Estimate Probability NPV Estimate Probability
Rs. 3,000 0.1 Rs. 3,000 0.2
6,000 0.4 6,000 0.3
12,000 0.4 12,000 0.3
15,000 0.1 15,000 0.2
You are required to compute:
i) the expected Net Present Value of Projects A and B.
ii) The risk attached to each project i.e., Standard deviation of each probability distribution.
iii) The Profitability Index of each project.
Which project do you consider more risky and why?

Comment by mkmpriya — April 30, 2009 @ 3:10

• Yenki Ltd. is considering two mutually exclusive projects A and B. Project A costs
Rs. 30,000 and Project B Rs. 36,000. The

NPV probability distribution for each project is
as given below :
Project A Project B
NPV Estimate Probability NPV Estimate Probability
Rs. 3,000 0.1 Rs. 3,000 0.2
6,000 0.4 6,000 0.3
12,000 0.4 12,000 0.3
15,000 0.1 15,000 0.2
You are required to compute:
i) the expected Net Present Value of Projects A and B.
ii) The risk attached to each project i.e., Standard deviation of each probability distribution.
iii) The Profitability Index of each project.
Which project do you consider more risky and why?

Comment by BINMA — May 1, 2009 @ 14:28

• Yenki Ltd. is considering two mutually exclusive projects A and B. Project A costs
Rs. 30,000 and Project B Rs. 36,000. The

NPV probability distribution for each project is
as given below :
Project A Project B
NPV Estimate Probability NPV Estimate Probability
Rs. 3,000 0.1 Rs. 3,000 0.2
6,000 0.4 6,000 0.3
12,000 0.4 12,000 0.3
15,000 0.1 15,000 0.2
You are required to compute:
i) the expected Net Present Value of Projects A and B.
ii) The risk attached to each project i.e., Standard deviation of each probability distribution.
iii) The Profitability Index of each project.
Which project do you consider more risky and why?

Comment by priya murali — May 8, 2009 @ 7:07

Assume you are working in a bank and one of your clients, Pear Ltd., applies for a loan
required for an investment into a new laptop series. During the last meeting with Pear
Ltd. the CEO of Pear Ltd. has informed you about the financial data regarding this
investment. These data are as follows:

-Project duration: 3 years (i.e. the laptop will be produced for three years)

-Required amount for the investment now: £ 15,000,000

-Expected quantities to be sold: year one: 10,800, year two: 12,500, year three:

9,600

-Price to be charged per laptop: year one: £ 760, year two: £ 800, year three: £ 780

-Variable costs per laptop: £ 250

-Total fixed costs directly related to the investment: £ 130,000 per year

-Total fixed costs due to overheads of Pear Ltd.: £ 110,000 per year

-Depreciation: linear within three years, i.e. £ 5,000,000 pear year

-Tax rate on Pear Ltd.’s profit: 35 %

-Cash to be invested into the project by Pear Ltd.: £ 5,000,000

-Requested loan: £ 10,000,000

Assume that you trust in the data given above (i.e. this issue has not to be discussed) and
that the only reason to reject the loan is that the investment is not worthwhile as such.
Moreover, assume that the market rate of return for an investment in bonds backed up by
the British government is 4.0 % per year (before tax) and you have to pay 4.2 % per year
for the money which your treasury department in the bank can offer you. Given the costs
for granting the loan (incl. costs for risks) you need a margin of 0.80 % per year to cover
these costs. Furthermore, as most of the cost related to grant the loan are generated during
the decision making about the loan your internal rules require a fee of 1.25% of the loan
granted if the decision is positive.

Would you grant the loan? If yes, under what conditions? Explain and critically assess

Kind Regards.

Comment by Peter.ade — May 9, 2009 @ 14:43

• The company invests \$10,000, it will be repaid in a single sum at the end of 10 years. During the first five years the investment grows by 15% (nominal), compounded monthly. During the second five years the rate is 18% growth (nominal), compunded quarterly. What is the internal rate of return (IRR) for the entire 10-years period? I’m stuck with this HM problem. Does anyone knows how to start this?

Comment by Joe — May 11, 2009 @ 9:47

• I could use help with a formula for NPV.
I am trying to use Excel to calculate the NPV of uneven cash flows over 39 years paid monthly.
These are annuity type payments.
They start at \$1,336 per month.
I want to show them increasing at 2.5% each year for the 39 years.
So, first 12 months it’s \$1,336 per month.
Next 12 months it’s \$1,369.40.
In other words, the payment goes up 2.5% each successive year.
I have the formula for level payments
=1136*(1-(1/(1+.025)^468))/(.025/12)
It’s the increasing payments that throws me. I’m using Excel 2007.
Is there a formula that accomplishes this without having to input a whole table of values to reference?

thanks

Mike

Comment by Mike D — July 13, 2009 @ 10:47

• Hi can you please help me with these 2 problems, quite urgent. Thank you so much.

A company wishes to assess whether it should lease or purchase outright a piece of plant, the following information is relevant:-

Purchase price of the plant £45000
Estimated life of 6 years
Expected residual value at the end of the 6 years is nil
The machine is expected to yield savings of £8000 per year
The machine can be leased at £6000 per year for 6 years
Money can be invested at 8% on the open markets
The company considers the rate of return for such an investment to be 10%

Using the Net Present Value method calculate the following:-

a) should the company lease or buy outright
b) at which investment rate would the choice become immaterial
c) approximately what would be the minimum annual lease cost
d) approximately at which initial outlay would purchase become favourable

2A company is considering the acquisition of new equipment. The terms of acquisition are

(a) initial payment of £150000

(b) followed by annual payments of £60000 in each of the next 5 years. At the end of the fifth year the machinery is to be bought outright for a further payment of £180000.

The machine is expected to provide a further 5 years of useful life before replacement becomes necessary, disposal costs of £75000 are expected. The new equipment is expected to provide operational savings of £110000 per year throughout its life. The cost of capital is 10%

Using Net Present Value:-

a) decide if the company should go ahead with the acquisition

b) what would be the lowest acceptable level of annual savings

c) What is the Internal Rate of Return for this project

thanking all for dis big big help

Comment by RAM — July 26, 2009 @ 6:44

• Hi,
I just wanted to say thank you. Your thinking of timeless reference has been great. I have been struggling with my finance class not understanding. Your examples were easy to understand and I think I can do this on my own.
Thanks Again,
Dani Medina

Comment by Dani Medina — September 13, 2009 @ 23:12

• It is a good site. I can see the questions only. Where are the replies?

Many thanks. I will appreciate the answers to the questions that have been posed.

Comment by Junaid K. Choudhury — September 15, 2009 @ 14:43

• I need help with an assignment, hope you can assist. It says:-

The purchase price of a machine is 500,000, depreciated on straight line over 5 years. Cash saving of 200,000 per annum before tax for 5 years. The machine will be sold for 75,000. Gain on the sale taxed at 40%. Is the investment attractive given all the cash flows. Assume that the cash flow happened at the end of each year. Tax rate=40%, appropriate discount rate = 8%. What is the NPV?, IRR and payback period. Hope to hear from you.

Comment by Samuel — October 1, 2009 @ 9:50

• Hi

Can you please assist me with this one :

Terminator Pest Control Limited projects unit sales for a new household-use laser-guided cockroach eradication system as follows:

Year Unit Sales
1 100000
2 105000
3 110000
4 114000
5 80000

The eradication system will require \$600 000 in net working capital (NWC) to start, and additional net working capital investments each year equal to 40 per cent of the projected sales increase for the following year. (Since sales are expected to fall in year 5 then, there is no NWC cash flow occurring for year 4.)
Total fixed costs are R200000 per year, variable production costs are R200 per unit, and the units are priced at R325 each. The equipment needed to begin production has an installed cost of R13 250 000. This equipment is to be depreciated for tax purposes over six years. At the end of the expected project life of five years this equipment can probably be sold for about 25% of its acquisition cost. The company pay
35% tax and has a required return on all its projects of 25%.

Based on these preliminary project
estimates, what is the NPV and IRR of the project?

Comment by Paul — October 8, 2009 @ 7:31

• projection with 50 million dollar investment in a airline business

Company iz investing 50 million which will results an incremental sales of 2 million in 1st year after the fleet has been launch.
The inflation rate is 10% use straight line method for 5 years.
and calculate NPV of project. The tax rate assume to be 35% . Calculate the cash flow.

Comment by waqas ahmed — November 30, 2009 @ 10:00

• Dear, Great full if you do not mind to help me with these two problems please.

1) a machine man is considering a four-year project to improve its productivity effeciency. Buying a new machine press for \$480,000 is estimated to result in 4160,000 in annual pretex cost savings. the press falls in the MARCS fiveyear class, and it willhave a salvage value at the end of the project of \$70, 000. the press also requires an initial investment in spare parts inventory of \$20,000. along with an additional \$3000 in inventory for each succeeding year of the project. if the shop’s tax rate is 35 percent and its discount rate is 15 recent, should him buy and install the machine press?

2) Calculating Project NPV – A restaurant is considering the purchase of a \$10,000 souffle maker. the souffle maker has an economic life of five years and will be fully depreciated by the staright-line method. The machine will produce 2,000 souffles per year, with each costing \$2 to make and price at \$5. Assume that the discount rate is 15 percent and the tax rate is 34 percent. Should the restaurant make the purchase?

Thanks.

Comment by Karl — December 9, 2009 @ 10:23

As part of the drive to reduce costs and increase profitability a company is considering investing in new manufacturing equipment. This equipment will require a large initial outlay and will result in positive cash inflows for the four-year useful life. The company commissioned and paid for a report by management consultants last year at a cost of £50,000 which forecast the following information on the equipment.

1. The equipment will cost £2,000,000. It can be sold after four years for £200,000 and should be depreciated at 25% per annum using the straight line basis. Capital allowances are available at 15% on a straight line basis.
2. An initial investment in working capital of £50,000 is required. This will be maintained for the four years. At the end of the four year period this will be recovered.
3. Production efficiencies of £500,000 per annum are expected in year 1 and these will grow at 3% per annum thereafter.
4. Annual savings on labour are expected to amount to £150,000 in year 1 growing at a rate of 5% per annum for each of the next three years.
5. The managing director of the company has indicated that £200,000 of existing head office costs will be allocated to the new machinery.
6. The rooms where the plant will be located is currently let out to a local business for £25,000 per annum.
7. The company pays corporation tax at the rate of 12.5% payable one year in arrears.
8. The company has a weighted average cost of capital of 10%. This was last calculated 3 years ago.

Requirement:

a) Calculate the NPV of the proposed project and justify your treatment of each cost referred to in the question.
12 Marks
b) Calculate 3 alternative methods of appraising this investment, explain each method and highlight the disadvantages of each relative to the NPV method.
12 Marks

Comment by Adam — December 9, 2009 @ 13:35

• Help!! I’m a grad student in managerial accounting and I never had to take an accounting class before. Here’s the scenario:

A company is considering the purchase of new equipment to manufacture specailty spark plugs. The new equipment would allow the firm to manufacture 100,m000 additional spark plugs per year and is expect to have a useful life of 5 yeas and to have no salvage value at that time. SAC will depreciate the equipment using the straight-line method. Specialty spark plugs are selling for an average price of \$20 and are expected to cost \$8 to manufacture with the new equipment. Indirect costs are expect to remain the same. The equipment will cost \$3 million to purchase and install.

The company intends to keep its capital structure intact in financing this equipment.

Capital Structure:

Stocks: % of capital-60%. Rate of return-14%

Bonds- % of capital 40%. Ratue of return- 6%

Is this a good investment for the company? What is it’s NPV and IRR. I have no idea what I’m doing.

Comment by Penny Klein — December 16, 2009 @ 14:23

• PS. SAC’s tax rate is 34%

Comment by Penny Klein — December 16, 2009 @ 14:28

• How to calculate the NPV for year 1 2 & 3 as I have the following data.

Month Assumption 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36

No. of Operators 5 5 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36
Call hours 1 200 500 875 1050 1225 1400 1575 1750 1925 2100 2275 2450 2625 2800 2975 3150 3325 3500 3675 3850 4025 4200 4375 4550 4725 4900 5075 5250 5425 5600 5775 5950 6125 6300

In-flow
Capital 500.00
Loan 2 400.00
Revenue 3 15.00 37.50 65.63 78.75 91.88 105.00 118.13 131.25 144.38 157.50 170.63 183.75 196.88 210.00 223.13 236.25 249.38 262.50 275.63 288.75 301.88 315.00 328.13 341.25 354.38 367.50 380.63 393.75 406.88 420.00 433.13 446.25 459.38 472.50
Total Cash Inflow 500.00 – – 415.00 37.50 65.63 78.75 91.88 105.00 118.13 131.25 144.38 157.50 170.63 183.75 196.88 210.00 223.13 236.25 249.38 262.50 275.63 288.75 301.88 315.00 328.13 341.25 354.38 367.50 380.63 393.75 406.88 420.00 433.13 446.25 459.38 472.50

Out-flow
Loan-payback 2 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00 20.00
Purchase & support 4 150.00 150.00 15.00 15.00
Office rent 5 100.00 100.00 100.00 100.00 100.00 100.00
Support Salaries 6 23.00 39.00 42.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 50.00 65.00 65.00 65.00 65.00 65.00 65.00 75.00 75.00 75.00 75.00 75.00 75.00 75.00 75.00 75.00 75.00 75.00 75.00 75.00
Operators Salaries 6 25.00 25.00 25.00 30.00 35.00 40.00 45.00 50.00 55.00 60.00 65.00 70.00 75.00 80.00 85.00 90.00 95.00 100.00 105.00 110.00 115.00 120.00 125.00 130.00 135.00 140.00 145.00 150.00 155.00 160.00 165.00 170.00 175.00 180.00
Phone Bill 7 1.20 3.00 5.25 6.30 7.35 8.40 9.45 10.50 11.55 12.60 13.65 14.70 15.75 16.80 17.85 18.90 19.95 21.00 22.05 23.10 24.15 25.20 26.25 27.30 28.35 29.40 30.45 31.50 32.55 33.60 34.65 35.70 36.75 37.80
Other expenses 8 50.00 20.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00 5.00
Total Cash outflow 73.00 309.00 42.00 231.20 83.00 85.25 91.30 197.35 103.40 109.45 115.50 121.55 127.60 233.65 139.70 180.75 171.80 177.85 198.90 304.95 211.00 217.05 223.10 229.15 245.20 351.25 257.30 278.35 269.40 275.45 281.50 387.55 293.60 299.65 305.70 311.75 317.80

Cumulative Net Cash 427.00 118.00 76.00 259.80 214.30 194.68 182.13 76.65 78.25 86.93 102.68 125.50 155.40 92.38 136.43 152.55 190.76 236.04 273.39 217.82 269.33 327.91 393.56 466.29 536.10 512.98 596.93 672.96 771.07 876.25 988.50 1,007.83 1,134.24 1,267.72 1,408.27 1,555.90 1,710.61

Comment by Honey — December 19, 2009 @ 11:48

• Hi, I need help in this question when doing the report. can you help me to interpret it?
“as there are no capital allowances tax is not an issue in deciding whether to go forward with the project”
as i know the tax will affect the result of the project and it is an issue, but in this question whether have or dont have tax the result is same. so how i insist my opinion that tax is an issue??

Comment by Ping — January 12, 2010 @ 7:25

• Smart Limited is an expanding company that makes a range of garden equipment and tools. The company is looking to update its range of cordless Hedge Trimmers by the introduction of a new product called the SuperStrimmie.

Initial outlay

If Smart Limited decides to proceed with the production of the SuperStrimmie, it will require an investment of £4,200,000 in a new machine. This machine will have a useful life of five years at which point the company believes it can be sold for £500,000. Depreciation is calculated on a straight line basis over the five years.

Demand and price

The SuperStrimmie is to be competitively priced at £70.00.
The sales and marketing director has already commissioned some preliminary market research at a cost of £140,000 and the results of this research suggest that likely demand for the new SuperStrimmie at this price will be as follows:

Year Demand
(units)
1 66,000
2 58,000
3 48,000
4 46,000
5 38,000

Costs:

The production manager and the finance director have spent considerable time analysing likely costs and they have arrived at the following:

Variable costs
Direct materials £14
Direct labour £8
Other variable costs £7
Total £29

In addition the SuperStrimmie will require an electric motor. The unit cost of making the electric motors in-house is as follows:

Materials (variable) £8
Labour (variable) £7
Total £15

If the electric motor is produced in-house, incremental fixed costs will increase by £35,000 per year.

A competitive bidding process has established that production of the motor for the SuperStrimmie could be sub-contracted to another supplier for the next five years. Any contract would run for the full, five year life of the SuperStrimmie. The unit cost charged by the supplier will depend on annual volume supplied as follows:

Annual volume (units) Sub-contract cost of the electric motor

0 – 50,000 £17
50,001 – 60,000 £16
60,001 – 70,000 £13

Batch related costs

The production manager has undertaken a costing exercise and has established that the SuperStrimmie will have the following batch related costs. These costs ‘vary’ each time a batch, or part batch, of the SuperStrimmie is produced.

SuperStrimmie
Machine Set-up costs per production run: £1200
Number of units per production run: 1,000
Quality assurance costs per 2,000 units produced £1,400

Incremental fixed costs

Other incremental maintenance and fixed costs associated with producing the new SuperStrimmie product are:

Cost per year:
years 1 and 2 Cost per year:
years 3 to 5
Machine maintenance costs £14,000 £26,000
Other fixed costs £62,000 £44,000

Impact on an existing product

The Sales and Marketing Director estimates that the introduction of the SuperStrimmie will affect demand of an existing product; the TimMie. Demand for the TimMie will reduce by 5% of the estimated volume of the SuperStrimmie in each year.

The unit contribution of the TimMie is £25.

Other information

Ignore inflation and taxation.

Assume the company’s cost of capital is 10%

What you need to do:

1) You should undertake a financial evaluation of whether the electric motor for the new SuperStrimmie should be subcontracted or produced internally.

2) Based on the decision you reach in part 1) together with the other data provided, calculate the:

Net Present Value (NPV), Internal Rate of Return (IRR), & Payback Period and the Accounting Rate of Return for the above project.

3) The Managing Director of Smart Limited has also asked you to prepare a product profit statement for each of the five years as follows:

Total Contribution from SuperStrimmie XXX
Lost Contribution from the TimMie (XXX)
Net Contribution XXX
Less batch related costs (XXX)
Less other incremental fixed costs (XXX)
Net Product cash flow XXX
Product depreciation (XXX)
Product Profit/(loss) after depreciation

Comment by jimmy — January 15, 2010 @ 14:19

• need help in this one
Assume that a customer shops at a local grocery store spending an average of \$150 a week and that the retailer earns a 5% margin. Calculate the customer lifetime value of this shopper remains loyal over a 10 yrs lifespan, assuming a 5% annual interest rate and no initial cost to acquire the customer

Comment by AS — January 17, 2010 @ 5:59

• how to calculate

Caltech is considering the purchase of a new printing press. The
total installed cost of the press is R2.2 million. This outlay would
be partially offset by the sale of an existing press. The old press
has zero book value, cost R1 million 10 years ago, and can be
sold currently for R1.2 million before taxes. As a result of
acquisition of the new press, sales in each of the next 5 years
are expected to be R1.6 million higher than with the existing
press, but product cost (excluding depreciation) will represent
50% of sales. The new press will be depreciated on a straightline
basis over 5 years and will be terminated at end of 5th year
for a scrap value of R90 000 . Caltech cost capital is 11%.
Assume a 29% tax rate.

initial investment
operating cash flow
terminal cash flow
NVP
IRR
Payback period

Comment by zam — January 27, 2010 @ 3:11

• I am having trouble trying to figure out how to set up present and future vaues using excel.
He is the problem I am working on.

On January 1, 2009, James Corporation sold a \$500,000, 7% bond issue dated January 1, 2009. The market interest rate on January 1, 2009, was 10%. The bonds pay interest each December 31, and mature December 31, 2018. James Corporation uses the effective-interest method of amortization.

Answer the following questions in Excel and submit your completed Excel file. Round calculated amounts to the nearest dollars.

Compute the bond issue price using the present value tables provided in Appendix C pages C-14 through C-16. The present value factors from the tables should be rounded to 4 decimal places when you use them in your calculations. Show your present value calculations.

Prepare a bond amortization schedule for these bonds using the format shown in supplement 14B.

In your amortization schedule, you may need to adjust your interest expense slightly in the last interest period due to the effects of rounding in the problem. If needed, you will adjust the interest expense so the ending balance of the unamortized bond discount or premium is exactly zero at the end of the last interest period.

Prepare the journal entry to record the issuance of the bonds on January 1, 2009.

Prepare the journal entry to record the interest payment on December 31, 2009.

Comment by Tonnie — January 28, 2010 @ 14:49

Cross Co. is able to sell one of its two machines. Both machines perform the same function but differ in age.

The newer machine can be sold today for \$40,000. Its operating costs are \$20,000 a year, but in 5 years the machine will require a \$50,000 overhaul. Thereafter operating cost will be \$30,000 a year until the machine is finally sold in year 10 for \$5,000.

The older machine can be sold today for \$20,000. If it is kept, it will need an immediate \$20,000 overhaul. After that the operating costs will be \$30,000 a year until the machine is finally sold in year 5 for \$5,000.

Both machines are fully deprecitated for tax purposes. The company pays 35% tax on the gain from selling a machine. Cash flows have been forecasted in real terms, and the cost of capital is 12%.

Which machine should Cross Co. sell?

Comment by ke — January 31, 2010 @ 0:00

• Leslie or anyone interested

could you kindly post the answers of the above questions here or email me them, as they would be a useful revision tool.

Thank you for this great website

Owen

Comment by Owen — February 25, 2010 @ 7:22

• will u help me on this one.. opus company is evaluating a capital investment proposal that requires an initial outlay of P200,000. The project will have a five-year life. net after-tax cash flows of the project are projected to be P80,000 in the first year, P60,000 in the second year, P52,000 in the third year, P32,000 in the fourth year, P36,000 in the fifth year, including the salvage value of P12,000 that is expected to be received at the end of the life of the project. The straight-line method will be used to depreciate the project. Income tax is 30% and the company’s cost of capital is 14%.
REQUIRED: Compute the net present value.

Comment by RJay — March 16, 2010 @ 7:30

• Plz help me out on the following problem, i am trying to work it out, but not succeed. Plz need ur help.

A company is considering purchasing a machine at a cost of \$90,000. The machine is forecast to generate cash flow savings of \$24,000 per year over an estimated useful life of six years and to have a salvage value after six year of \$6,000. For tax purposes the machine can be depreciated at 20% per annum straight line method or 30% per annum reducing balance method (with no salvage allowance in either case). The company tax rate is 30% and the discount rate for evaluating projects of this type 12%. Apart from the initial outlay of \$90,000, all cash flows (including tax payments and benefits) are assumed to occur at year end.

Req:1 What is the NPV and Internal Rate of Return of the project using straight line method.

Req:2 What is the NPV and Internal Rate of Return of the project using reducing balance method.

Thx

Jimmy

Comment by Jimmy — March 23, 2010 @ 21:51

• Hello,

I’m just entering into the University for the business, anyone can help to give some clues on this question?

A firm has undertaken a feasibility study to evaluate a project that has the following estimated cashflows:

o Increased sales to business of \$140,000 for the next 5 years (starting in one year’s time)

o Increased costs of \$20,000 for the next two years (starting in one year’s time)

o The initial capital expenditure required is \$100,000.

o The study cost \$10,000 to conduct.

-Amount borrowed to fund project is \$200,000 with interest of 8% pa paid yearly.

If the firm is facing a discount rate of 10%, what is the NPV of this project?

Many thanks for your kind assistance.

Comment by Kitty — April 21, 2010 @ 6:56

1. M/s Gas Ltd. Have estimated the following probabilities for net cash flows generated by a project. You are required to calculate the present value of the expected monetary cash flows at 10% discount rates. The following information has been made available to you:
1st Year 2nd Year
Cash Inflow ProbabilityCash . Probability
100 .10 100 .20
200 .20 200 .30
300 .30 300 .40
400 .40 400 .10

Comment by Amrut Dixit — April 27, 2010 @ 0:17

• Hi!

I just want to ask your thoughts on the option of either purchasing company cars or continue leasing cars from an external entity. Which is more beneficial to the company?

Thanks!

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Comment by AG — April 28, 2010 @ 6:06

• Kindly help me to solve this problem:

Volga is a large manufacturing company in the private sector. In 2007 the company had a gross sale of Rs. 980.2 crore. The other financial data for the company are given below:

Items In crores
Networth 152.31
Borrowing 165.47
EBIT 43.17
Interest 34.39
Fixed cost (excld interest) 118.23
Pls calculate the
1. Debt equity ratio
2. Operating leverage
3. Financial leverage
4. Combined leverage.

Comment by Manoj — May 17, 2010 @ 7:53

• Java Café is considering two possible expansion plans. Plan A is to open 8 cafés at a cost of \$4 180 000. Expected annual net cash inflows are \$780 000, with residual value of \$820 000 at the end of seven years.
Under plan B, Java Café would open 12 cafés at a cost of \$4 200 000. This investment is expected to generate net cash inflows of \$994 000 each year for seven years, which is the estimated useful life of the properties. Estimated residual value of the plan B cafés is zero. Java Café uses straight-line depreciation and requires an annual return of 14%.

Required
1. Calculate the payback period, the accounting rate of return, and the net present value of each plan. Use the residual value when calculating the accounting rate of return, but assume a zero residual value when calculating the net present values. What are the strengths and weaknesses of these capital budgeting models?

2. Which expansion plan should Java Café adopt? Why?

Comment by mohammed — June 23, 2010 @ 20:21

• The company is expected to expand its business in to a new region with an initial investment of \$100 million. They expect to generate cash flow in year 1 and revenue is expected to increase by \$25 million per year (attributable to this new project). The company estimates fixed cost associated with the expansion to be \$5 million per year and variable costs will be 70% of revenue. For accounting purposes, the initial investment will be depreciated on a straight line basis for 15 years. Loblaw will pay taxes in Canada and it will be 40%.

1. Calculate the NPV of this project.

2. Calculate the accounting break-even sales and NPV break-even sales of the project.

3.
3. Calculate the Economic Value Added break-even sales and comment on the difference between accounting break-even sales and the break-even identified through Economic Value Added.

Comment by Beatrice — July 22, 2010 @ 16:48

• Hi
Your site is really useful to those international students who are really starting this subject but are unknown to the practice.
Thanks!

Comment by keshab — July 23, 2010 @ 4:05

• How to evaluate the net presest value if the outlays are given different?

Comment by Ramesh Thapa — July 27, 2010 @ 10:34

• ap ltd trying to evaluate 4 new project. assume all 4 project have useful life of 10 years.the project are mutually exclusive.
project: 1 2 3 4
annual netcash flow:100000 70000 E G
initial investment: 449400 C 200000 300000
cost of capital: 14% 14% F 12%
IRR: A 20% 14% H
NPV: B D 35624 39000
calculate A B C D E F G H from the above.
its urgent..plz show me the required step and details to do it..

Comment by lovely — August 12, 2010 @ 0:20

• @Jones – Certainly an interesting case,

the NPV would be: \$30,000

I might be wrong on the standard deviation but I get: 2790000000\$

I don’t think the std dev is very meaningful when you get an average of nearly 0 and such a wide range of possibilities. I guess I would use the NPV personally as well as the willingness of the owner to sustain huge losses, that while improbable are certainly possible. It then becomes more of a qualitative argument and depends more on your attitude towards risk. What are your thoughts? Personally, I think that any project that has such a wide range with an average near 0 will make the std dev basically meaningless….

Comment by Experiglot — October 16, 2011 @ 19:46

• Year

1

2

3

4

5

Sales (units/yr)

250,000

400,000

500,000

250,000

€000

€000

€000

€000

€000

Contribution

1,330

2,128

2,660

1,330

Fixed costs

(530)

(562)

(596)

(631)

Depreciation

(438)

(438)

(437)

(437)

Interest payments

(200)

(200)

(200)

(200)

Taxable profit

162

928

1,427

62

Taxation

(49)

(278)

(428)

(19)

Profit after tax

162

879

1,149

(366)

(19)

Sales proceeds

250

After-tax cash flows

162

879

1,149

(116)

(19)

Discount at 10%

0.909

0.826

0.751

0.683

0.621

Present values

147

726

863

(79)

(12)

Net present value = 1,645,000 – 2,000,000 = (€355,000) therefore the recommendation is to reject the project.

1. The project would require an initial investment of €2 million

2. Selling price: €12/unit (current price terms)

3. Variable cost: €7/unit (current price terms)

4. Fixed overhead costs: €500,000/year (today’s price terms)

5. €200,000/year of the fixed costs refer to development costs that have already been incurred and are being recovered by an annual charge to the project

6. Blake intends to finance the investment by means of a €2 million loan at a fixed interest rate of 10% per annum

7. The company pays tax one year in arrears at an annual rate of 30% and claims capital allowances on machinery on a 25% reducing balance basis

8. The proceeds on disposal of the machinery at the end of the four-year project is €250,000

9. The real weighted average cost of capital of Blake Co is 7% per annum

10. The general rate of inflation is expected to be 4.7% per annum, selling price inflation is 5% per annum, variable cost inflation is 4% per annum and fixed cost inflation is 6% per annum.

Using the appraisal methods you have recommended in, comment on the project’s acceptability.
I have got the answer for this by recalculating which is +1784,000npv.
can you check it that is it correct or not and can briefly comment on this project acceptability.
Hope so will hear from you very soon.
Many thanks

Comment by Afridi khan — February 13, 2012 @ 17:58

• I cannot figure out how to solve this problem!!!!! HELP PLEASE!!!!

Summer Tyme, Inc., is considering a new 3-year expansion project that requires an initial fixed asset investment of \$3.456 million. The fixed asset will be depreciated straight-line to zero over its 3-year tax life, after which time it will have a market value of \$268,800. The project requires an initial investment in net working capital of \$384,000. The project is estimated to generate \$3,072,000 in annual sales, with costs of \$1,228,800. The tax rate is 33 percent and the required return on the project is 11 percent. The NPV for this project is

Comment by Lauren — March 1, 2012 @ 9:39

• hi can u help anyone with this excercise?

The Government of Tanzania is in the process of establishing a Nature reserve in an important water catchment and a biodiversity hotspot in the Rungwe mountain ranges in Southern Tanzania. It harbours a recently discovered species of monkey (Rungwecebus Kipunji) which has been classified by IUCN as critically endangered. The plateau of Rungwe Mountain known as Kitulo plateau is alternatively known as ‘God’s Garden’ because of its beauty and large number of endemic flowering plants. The area has fallen victim to illegal logging, primate hunting among others threatening the extinction of this wonderful heritage.

The project lifetime is 30 years and is expected to bring benefits to the country in terms of environmental benefits which will bring about eco-tourism trade in the area.
Investments costs of the project are the initial costs of clearing land and setting up the Nature Reserve amounts to 19millC.U. in year 1, Operating costs include employment of wardens and gardeners which comes to 0.3mill C.U per year in constant prices for the project lifetime. The main cost is the opportunity cost arising from loss of income suffered by the local inhabitants who would have used the land for cultivation rice and other food crops and collection of Non Timber Forest Products (NTFPs). The net value of these foregone use products (value of the goods less the cost in terms of the time and resources that would have been used to obtain them) defines an annual opportunity cost per acre of land set aside for the project. Thus estimated opportunity cost per acre multiplied by the total area covered by the proposed nature reserve equals the income loss to the economy from the new land use (i.e. establishment of nature reserve) which is equivalent to 4.5mill C.U annually for the project lifetime.
Benefits of the project are the consumer satisfaction derived from the preservation of natural areas and the species that make the area their habitat. To get the value of this kind of benefit, a CVM study has been applied by asking tourists who currently visit the area close to the site and values have been obtained. In order to get the annual global benefits from the project, the conservative assumption used is that the number of tourists visiting the nature reserve will be the same for the lifetime of the project from when the park is open.
Although the lifetime of the project is 30 years, the reserve is assumed to continue to offer benefits beyond the 30 years. Terminal benefit value is taken to be 20 times of the environmental benefits figure in year 30. The unadjusted amount is 100mill C.U. in constant prices is included in the last year of the project life.
It is assumed that willingness to pay for the services provided by the nature reserve rises by 3% annually due to increasing popularity of the tourist attraction, hence increasing environmental benefits of the reserve. The unadjusted benefits in constant prices are 5mill. C.U and therefore these grow by 3% each year.
All the values are expressed in mill C.U constant prices and the discount rate used is the real social discount rate of 10%.
a) Calculate the NPV and IRR for the project using the unadjusted constant values of environmental benefits and terminal value
b) Calculate the NPV and IRR for the project using the adjusted values of environmental benefits and terminal value

Comment by Sufia — March 10, 2012 @ 7:57

• We are evaluating a project that costs \$1,666,000, has a seven-year life, and has no salvage value. Assume that depreciation is straight-line to zero over the life of the project. Sales are projected at 88,300 units per year. Price per unit is \$34.90, variable cost per unit is \$21.15, and fixed costs are \$763,000 per year. The tax rate is 30 percent, and we require an 12 percent return on this project.Suppose the projections given for price, quantity, variable costs, and fixed costs are all accurate to within ±10 percent. Calculate the best-case and worst-case NPV figures Best Case? Worst Case?

Comment by Lisa — March 25, 2012 @ 13:34

• A company is considering a capital project with the following information:
The cost of the project is Rs.200 million, which consists of Rs. 150 million in plant a machinery and Rs.50 million on net working capital. The entire outlay will be incurred in the beginning. The life of the project is expected to be 5 years. At the end of 5 years, the fixed assets will fetch a net salvage value of Rs. 48 million ad the net working capital will be liquidated at par. The project will increase revenues of the firm by Rs. 250 million per year. The increase in costs will be Rs.100 million per year. The depreciation rate applicable will be 25% as per written down value method. The tax rate is 30%. If the cost of capital is 10% what is the net present value of the project.

Comment by reshma — April 6, 2012 @ 6:03

• There was a replacement of its existing machine by a new machine. The new machine will cost Rs 2,00,000 and have a life of five years. The new machine will yield annual cash revenue of Rs 2,50,000 and incur annual cash expenses of Rs 1,30,000. The estimated salvage of the new machine at the end of its economic life is Rs 8,000. The existing machine has a book value of Rs 40,000 and can be sold for Rs 20,000. The existing machine, if used for the next five years is expected to generate annual cash revenue of Rs 2,00,000 and to involve annual cash expenses of Rs 1,40,000. If sold after five years, the salvage value of the existing machine will be negligible.
The company pays tax at 40%. It writes off depreciation at 30% on the written down value. The company’s cost of capital is 20%
Compute the incremental cash flows of replacement decisions.

Comment by reshma — April 6, 2012 @ 6:07

• Need help solving this.

Company ABC is considering an expansion project. To date they have spent \$75,000 investigating the viability of the project and have decided to proceed. The proposed project has an initial cost of \$500,000 and will be depreciated over a 3 year MACRS class life.
MACRS
Depreciation
Year Rates
1 0.33
2 0.45
3 0.15
4 0.07
If the project is undertaken the company will need to increase its inventories by \$50,000, and its accounts payable will rise by \$10,000. The company will realize an additional \$600,000 in sales over each of the next four years. The company’s operating costs (not including depreciation) will equal \$400,000 a year. The company’s tax rate is 40%. At t = 3, the project’s economic life is complete, but it will have a salvage value (before-tax) of \$50,000 after three years. The project’s WACC is 10%.
a) What is the project’s net present value (NPV)? What is the IRR?
b) Should the project be accepted? Why or why not? (i.e. Explain what your numerical answer means.)

Comment by Nikki — April 18, 2012 @ 10:17

• Hi,

I have a question. Can you only calculate the NPV for a new investment/project? What if I am going to invest in an entire new business. I will be needing a machine, computers, buildings. Is it possible to use NPV to determine wether or not the business will be feasible?
If I can, how do i do this in excel?

Thank you

Comment by Stephanie — May 16, 2012 @ 7:47

• “The construction industry remained steady and is estimated to grow at 4.0% by the end of the
2008 calendar year, compared to 4.6% in 2007 (source: Economic Report 2008/2009). The
Group’s construction division continued to perform steadily throughout the year under review,
completing construction on several phases of residential housing projects, and continuing work
on the Electrified Double Track Railway Project between New town and South for Malaysia’s Ministry of Transport.”
Being enthusiastic with the report on growth of construction industry above, Mira Edora, the
founder of Edora Simbolik Holdings, a construction company, is considering two investment
opportunities. Due to limited resources, Mira will be able to invest in only one of them. The
details of the projects are as follows:
Project A
Purpose: to purchase a new machine that will enable factory automation
Initial cash expenditure: RM400,000
Expected useful life of machine: four (4) years, no salvage value
Annual expected cash inflows: RM126, 188
Project B
Purpose: to support a training programme that will improve the skills of employees operating the
current machine
Initial cash expenditure: RM160,000
Annual expected cash inflows: RM52,676
Both projects are expected to provide cash flow benefits for the next four years. Edora Simbolik
Holdings’ cost of capital is eight (8) per cent.
Required:
a. Compute the net present value of each project. Which project should be adopted based
on the net present value approach?
[10 marks]
b. Compute the approximate internal rate of return of each project. Which project should be
adopted based on the approximate internal rate of return approach?
[10 marks]
c. Compare the net present value approach with the internal rate of return approach. Which
method is better in the given circumstances? Why?

Comment by Shiira — June 19, 2012 @ 23:09

• I have been searching the web for some topics in Finance but I didn’t get through until I came across your site. Thanks for the way you explained to me. Please, could you help with the books to read in preparation for my M.Sc in FINANCE. And also is there any Software on all the topics and calculations that would be treated in FINANCE as Course. And if there is, how can I get them. Bear in mind that I’m in Nigeria. I need an urgent reply because time is no more on my side – I’ll be sitting for the entrance exams by August… and I need to read. Thanks so much.

Comment by Modupe Oredola — July 11, 2012 @ 5:52

• Please I need assistance in solving this problem below:

Epitasis PLC is a small company engaged in house building. The company is considering the purchase of a piece of land that is for sale at a cost of 10million. Two suggestions have been made for the use of land. One is to construct a number of private houses for sale and other is to construct and operate an amusement Park. The company’s management accounts have made the following estimates of the net cash flows for both projects (including the cost of the land) See Appendix2 for discounting tables. Year Private House Development Amusement Park

Year Private House Development Amusement
£m £m

0 -10 -10
1 -5 -8
2 +7 +4
3 +9 +6
4 +4 +8
5 +7
6 +9

The company uses NPV to evaluate projects and normally takes 10% as the discount rate, as this reflects the return available elsewhere on house building investments. In the present circumstances this appears to be a suitable rate for the house building project but not for the Amusement Park. After much research the company has decided that the minimum rate of return for the amusement park should be 18%.
• As finance Managers of your organization, assess the factors to be considered when taking investment decision for directors.
• Using the minimum rate of return required for each of the projects calculate the NPV for each project; the house building project and the Amusement Park
• Critically apprise the NPV values calculated in part (b) and state, which reasons, which projects you would advise epitasis PLC to proceed with.
• . As a manager of fashion industry, your CEO has asked you to evaluate Payback Period and internal rate of return. Which one would you recommend for fashion industry and why?

Comment by Sulemana Haruna — October 29, 2012 @ 6:57

• Wow, that’s what I was seeking for, what a stuff! existing here at this web site, thanks admin of this site.

Comment by 10 Quick Ways To Make Money — November 1, 2012 @ 13:58

• Please I need assistance in solving this problem below:

Project A:
The initial investment on the project is R100 000 and a second investment of R15 000 is required at the start of year two. At the middle of year two, the first inflow will occur to the estimated value of R30 000. At the end of year two, there will be a further inflow of R20 000 and at the end of year three a final inflow of R40 000.
Project B:
The initial investment on the project is R150 000 and no further investment will occur. The first inflow will occur at the end of year one to the estimated value of R15 000. At the end of year two, there will be a further inflow of R25 000 and at the end of year three a final inflow of R75 000.
The organisation would like to realise a return on investment of 8%.

4.1. Calculate the Nett profit for each project over the 3 years and provide a recommendation.

4.2. Calculate the NPV for each project (use tables) and provide a recommendation.

4.3. Calculate the Return on Investment (ROI) of project 1. Show formulas and calculations. Do NOT consider the time value of money (discount the inflows and outflows). Provide a recommendation.

4.4. Calculate the payback period for each project. Show calculations and provide a recommendation.

4.5. Taking into consideration your calculations, would you recommend project A or project B to develop? Justify your answer.

Comment by Alok — February 26, 2013 @ 5:16

• Will somebody answer this question.

Comment by Alok — March 20, 2013 @ 3:39

• I comment each time I especially enjoy a post on a blog or if I have something
to add to the conversation. Usually it is a result of the
passion displayed in the post I looked at. And after this article Experiments in Finance – Comments on How to calculate net present value
(NPV) – an introduction. I was moved enough to drop a leave
a responsea response ;-) I actually do have
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Comment by simply click the up coming internet site — April 15, 2013 @ 23:33

• The company can raise 800 million to finance future projects
Debt 250 million at 6%
550 million at 8%
Equity
Tax rate 30 %

Cost of Project 1 – 230 millions
Per Million NI Depreciation Current Assets Current Liabilities Long term Liabilities
Year 1 – 3 1 2 -3 2
Year2 150 3 -1 2 -2
Year 3 75 1 -1 2 3
Year 4 40 0.5 2 2 1
Year 5 5 1 0 0 1

Cost of Project 2- 500 millions
Per Million NI Depreciation Current Assets Current Liabilities Long term Liabilities
Year 1 -3 1 2 3 2
Year2 250 1 -3 -2 -2
Year 3 250 1 -3 2 3
Year 4 40 0.5 2 2 0
Year 5 5 1 0 0 1

Cost of Project 3- 300 millions
Per Million NI Depreciation Current Assets Current Liabilities Long term Liabilities
Year 1 5 1 2 -3 2
Year2 150 1 3 -2 -2
Year 3 200 1 3 2 3
Year 4 40 0.5 2 2 0
Year 5 5 1 0 0 1

Simulation table

8% 9% 10% 11% 12% 13%
NPV project 1 25 5 -2 -8 -10 -20
NPV project 2 60 50 30 3 -2 -3
NPV project 3 20 15 5 -1 -3 -4

1- Kindly evaluate the three projects based on the NPV analysis, Discounted Payback Period and IRR analysis? Which project is the best?
2- If the WACC is now 15% which project would you accept based upon NPV and IRR?
Please i need a help :'(

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• Internal rate of return is the rate of return used to measure the profitability of investments in the projects. Thanks for providing the cost details for the feasibility study of the project. As said by other this information will be very useful for the students who do projects on financial concepts.

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• Help!! Can you solve this problem?

A new machine requires an investment of A500,000 and will generate profits of A100,000 for 10 years.
Will the investment have a positive net present value assuming that a realistic interest is 6 per cent?

A local government housing office is considering investing in a new computer system for managing the
maintenance of its properties. The system is forecast to generate savings of around £100,000 per year and
will cost £400,000. It is expected to have a life of 7 years. The local authority expects its departments to use a
discount rate of 0.3 to calculate the financial return on its investments. Is this investment financially worthwhile?

In the example above, the local government’s finance officers have realized that their discount rate has been
historically too low. They now believe that the discount rate should be doubled. Is the investment in the new
computer system still worthwhile?

A new optical reader for scanning documents is being considered by a retail bank. The new system has a fixed
cost of A30,000 per year and a variable cost of A2.5 per batch. The cost of the new scanner is A100,000. The
bank charges A10 per batch for scanning documents and it believes that the demand for its scanning services
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year from year 4 onwards. If the realistic discount rate for the bank is 6 per cent, calculate the net present value
of the investment over a 5-year period.

Comment by Andy Novian Ragiltya — February 19, 2014 @ 14:50

year CF
0 -2600
1 4000
2 5000
3 6000
4 1000
calculate internal rate of return?
please tell how to decide what rate should be used to discount cash flow in these type of questions?

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You are a risk-averse investor considering an investment that requires an initial outlay of �50,000. You have calculated the present values of the future distribution of gains and losses, their associated probabilities, as well as their equivalent utilities based upon a personal utility function that conforms to Figure 2.5. The summarised data is as follows:

Cost Discounted gains and losses
�000s (50) 200 100 50 (10) (15)
Probability 1.0 0.1 0.3 0.4 0.1 0.1
Utility 0.65 1.67 1.00 0.65 (0.75) (1.52)

Using the concept of expected monetary value (EMV), would you accept the investment based upon its E(NPV)?

How does your answer compare with a decision using the present value of the cash flows of your expected utilities drawn from Figure?

and finally
Do you think mean variance analysis would alter your final choice? You need not calculate the standard deviation. Just write down a brief explanation of what it has to offer.

Thanks

Comment by rose — August 19, 2014 @ 6:14

• Technotronic Ltd currently requires payment from customers by the month end after the month of delivery (45 days). On average, it takes them 87 days to pay. Sales amount to �2 million per year and bad debts to �40,000 per year. It is planned to offer customers a cash discount of 2% for payment within 30 days. Technotronic estimate that 50% of customers will accept this facility but the remainder will not pay until 80 days after the sale. At present, the company has an overdraft facility costing 10% per annum. If the plan goes ahead bad debts will fall to �20,000 per annum and there will be savings in credit administration of �10,000 per annum.

Should Technotronic offer the new terms to customers?

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• Hi, Can you help me with this question?

A five-year financial project is expected to have cash inflow of 10,000, 25,000, 45,000, 20,000, and 50,000 in the next five years. It will cost \$15,000 at the beginning of year one, \$10,000 at the end of year one, and \$5000 at the end of year two to buy the necessary equipment for the project. We found that the project cleared the barrier of a 5 percent hurdle rate for acceptance while the expected annual inflation rate is 2 percent. What is the NPVof the project? (Assume all the cash inflow occurs at the end of each year.)

Comment by prem — October 24, 2014 @ 23:49

• Plea can u help me out
A company wants to install a plant costing RS 1000000 in jan2015.A plant is expected additional sales of its product .The forecasted sales and the operating cost of the machine is 6yrs .After which it can be sold as scrap for rs 40000!depreciation is on straight line basis .The cost of capital is 10% and the tax rate are expected to remain at 30% .The company has deffered tax liability worth RS 1000000 for which 6% interest is to be payable annually ?Working capital to be introduced in the beginning of the project RS 80000 .The machine will require a replacement of part at the end of the 3rd year and an amount RS 50000 has to be invested .The statement of expected sales and cost are given for different years

Year. Sales(in lakhs). Operating cost

2015. . 9. 450000
2016. 10. 450000
2017. 12. 500000
2018 14. 500000
2019. 15. 600000
2020 15.6. 600000
Find the N.P.V of the project and make your recommit ion regarding its exceptances.
What is the I.R.R of the project.

Comment by Dayasarki — November 16, 2014 @ 9:24

• Hi, Can you help me to solve this question?

A five-year financial project is expected to have cash inflow of 10,000, 25,000, 45,000, 20,000, and 50,000 in the next five years. It will cost \$15,000 at the beginning of year one, \$10,000 at the end of year one, and \$5000 at the end of year two to buy the necessary equipment for the project. We found that the project cleared the barrier of a 5 percent hurdle rate for acceptance while the expected annual inflation rate is 2 percent. What is the NPVof the project? (Assume all the cash inflow occurs at the end of each year.)

Comment by manisha lakum — November 28, 2014 @ 1:43

The Kretovich Company is trying to evaluate a capital budgeting project based in Thailand. It has recently completed a \$200,000, two-year study on its latest project. It estimated that 20,000 of its new geothermal heat pump could be sold annually over the next ten years at a price of \$8,521 each. Subcontractors would install the pump at a cost of \$6,200 per installation. Fixed costs of \$10 million per annum will be incurred.
The initial outlay includes \$50 million to build production facilities and \$2.4 million in land. The facility will be depreciated using the prime cost method over the project’s life (fully depreciated at the end of the project). At the conclusion of the project the facilities (including the land) will be sold for an estimated value of \$10 million. The land value is expected to increase by 1 per cent annually over the project period.
The firm is an ongoing profitable business and pays taxes at a 30% rate in the year of income. It uses a 12% discount rate on the new project. Using the NPV approach, advise the firm whether the project should be undertaken.

Comment by kelvin — April 1, 2015 @ 19:54

Technotronic Ltd currently requires payment from customers by the month end after the month of delivery (45 days). On average, it takes them 87 days to pay. Sales amount to �2 million per year and bad debts to �40,000 per year. It is planned to offer customers a cash discount of 2% for payment within 30 days. Technotronic estimate that 50% of customers will accept this facility but the remainder will not pay until 80 days after the sale. At present, the company has an overdraft facility costing 10% per annum. If the plan goes ahead bad debts will fall to �20,000 per annum and there will be savings in credit administration of �10,000 per annum.
Should Technotronic offer the new terms to customers?

Comment by Zayn browne — April 16, 2015 @ 9:21

• Hello,

I’m just entering into the University for the business, anyone can help to give some clues on this question?

A firm has undertaken a feasibility study to evaluate a project that has the following estimated cashflows:

o Increased sales to business of \$140,000 for the next 5 years (starting in one year’s time)

o Increased costs of \$20,000 for the next two years (starting in one year’s time)

o The initial capital expenditure required is \$100,000.

o The study cost \$10,000 to conduct.

-Amount borrowed to fund project is \$200,000 with interest of 8% pa paid yearly.

If the firm is facing a discount rate of 10%, what is the NPV of this project?

Many thanks for your kind assistance.

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