UBFF2013 BUSINESS FINANCE (MAY 2015)

UNIVERSITI TUNKU ABDUL RAHMAN

FACULTY OF BUSINESS AND FINANCE

ACADEMIC YEAR 2015 / 2016

TUTORIAL 9

Learning Outcome:-

On completion of this unit, a student shall be able to:

Explain the role of capital budgeting techniques in the capital budgeting process. Calculate, interpret and evaluate payback period, net present value, profitability index and internal rate of return.

9-1 What are the most commonly used capital budgeting procedures?Why is capital-budgeting decision so important? Why are capital-budgeting errors so costly?

9-2The treasurer of Anthony Press. has projected the cash flows of projects A, B, and C as follows. The required rate of return on both projects is 12 %.

YearProject AProject BProject C

0(RM100,000)(RM200,000)(RM100,000)

170,000130,00075,000

270,000130,00060,000

a. Compute the profitability indices for each of the three projects.

b. Compute the NPV for each of the three projects.

c. Suppose these three projects are independent. Which project (s) should Anthony accept based on the profitability index rule?

9-3 Jojo is reviewing a project with an initial cash outflow of RM250,000. An additional RM100,000 will have to be invested after the first year, followed by an additional investment of RM50,000 at the end of the second year. Beginning at the end of year three, the project is expected to generate cash flows of RM90,000 per year for the next eight years. Calculate the projects payback period, net present value (NPV), and internal rate of return (IRR) at a cost of capital of 8 percent.

YearCash FlowsCumulative

(RM)

0(250,000)(250,000)

1(100,000)(350,000)

2(50,000)(400,000)

390,000(310,000)

490,000(220,000)

590,000(130,000)

690,000(40,000)

790,00050,000

890,000

990,000

1090,000

9-4Lesley Sdn. Bhd. is attempting to evaluate the feasibility of investing RM95,000 in a piece of equipment that has a 5-year life. The firm has estimated the cash inflows associated with the proposal as shown in the table. The firm has a 12% cost of capital

Year (t)Cash inflows (CFt)

1RM20, 000

225,000

330,000

435,000

540,000

(i) Calculate the payback period

(ii) Calculate the net present value (NPV)

(iii) Calculate the internal rate of return (IRR)

(iv) Evaluate the acceptability of the proposed investment using NPV and IRR. What recommendation would you make relative to implementation of the project? Why?

9-5Valley Products, Inc. is considering two independent investments having the following cash flow streams: Year Project A Project B 0 -$50,000 -$40,000 1 +20,000 +20,000 2 +20,000 +10,000 3 +10,000 +5,000 4 +5,000 +40,000 5 +5,000 +40,000

Valley uses a combination of the net present value approach and the payback approach to evaluate investment alternatives. It requires that all projects have a positive net present value when cash flows are discounted at 10 percent and that all projects have a payback period no longer than 3 years. Which project or projects should the firm accept? Why?

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