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A piece of equipment requiring the investment of 2.2 million is being considered by Charo Foods Ltd. The equipment has a ten-year useful life and...
(Solved)
A piece of equipment requiring the investment of 2.2 million is being considered by Charo Foods Ltd. The equipment has a ten-year useful life and an expected salvage value of Sh 200,000. The company uses the straight-line method of depreciation for analyzing investment decisions and faces a tax rate of 40%. For simplicity assume that the depreciation method is acceptable for tax purposes.
A pessimistic forecast projects cash earnings before depreciation and taxes at Sh 400,000 per year compared with an optimistic estimate of Sh 500,000 per year. The probability associated with the pessimistic estimate is 0.4 and 0.6 for the optimistic forecast. The company has a policy of using a hurdle rate of 10% for replacement investments, 12% (its cost of capital) for revenue expansion investments into existing product lines and 15% projects involving new areas or new product lines.
REQUIRED:
(a) Compute the expected annual cash flows associated with the proposed equipment investments.
(b) Would you recommend acceptance of this project if it involved expansion of sales for an existing product?
(c) Would it be acceptable if it was for the replacement of equipment with a book value of Sh 200,000 at the end of the tenth year but which could be sold at that time for only Sh 40,000?
(d) Discounted cash flow methods were developed for idealized settings of complete and perfect capital, factor and commodity markets. Explain what complications arise when an attempt is made to apply these methods in real life markets that are neither complete nor perfect.
Date posted:
April 13, 2021
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Answers (1)
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The Mentala Plastics Company has been dumping in the local council waste collection
centre some 30,000 Kg. of unusable chemicals each year. In addition to being...
(Solved)
The Mentala Plastics Company has been dumping in the local council waste collection
centre some 30,000 Kg. of unusable chemicals each year. In addition to being an
eyesore, the residents of a nearby estate have started complaining of bad odour
emanating from the dump and suspect that the company is to blame.
The company has received information that these chemicals can be recycled at relatively little
cost. The equipment to do it is however rather expensive and, in addition, the chemicals
recovered are of a relatively poor quality. Investigations have shown that these chemicals can
be sold to another firm at an average price of Sh.35 per Kg. The direct cost of recycling has
been calculated at Sh.15 per Kg. but this is before depreciation and taxes.
The equipment for this process has an expected life of 10 years and a current cost of Sh.2 million. At the
end of the ten years, it will be virtually worthless.
For financial analysis, the company uses the straight line method of depreciation and an average tax rate of
40%. It has a required rate of return of 15%.
REQUIRED:
i. Compute the project's net present value (N.P.V).
ii. Compute the payback period and the accounting rate of return.
iii. Compute the internal rate of return (IRR).
iv. Should this project be undertaken? Explain.
Are there any other important matters that the company should consider in evaluating this project?
Date posted:
April 13, 2021
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Answers (1)
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Explain the concept of "rate of interest" in the context of financial decisions.
(Solved)
Explain the concept of "rate of interest" in the context of financial decisions.
Date posted:
April 13, 2021
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Answers (1)
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The Zeda Company Ltd. is considering a substantial investment in a new production process. From a
variety of sources, the total cost of the project has...
(Solved)
The Zeda Company Ltd. is considering a substantial investment in a new production process. From a
variety of sources, the total cost of the project has been estimated at Sh.20 million. However, if the
investment were to be increased to Sh.30 million, the productive capacity of the plant could be substantially
increased. Due to the nature of the process, it would be exorbitantly expensive to increase capacity once the
equipment is installed.
Once of the problems facing the company is that there is a considerable degree of uncertainty regarding
demand for the product. After some research which has been conducted jointly by the marketing and
finance departments, some data has been produced. These are shown below:
REQUIRED:
(a) Prepare a statement which clearly indicates the financial implications of each of the two alternative
investment scenarios.
(b) Comment on other matters which the management should take into account before reaching
the final decision.
PVIFA: 10% 5 years = 3.79
PVIFA: 10% 10 years = 6.14
PVIFA: 10% 10 years = 0.62
Date posted:
April 13, 2021
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Answers (1)
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State the disadvantages of utility approach.
(Solved)
State the disadvantages of utility approach.
Date posted:
April 13, 2021
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Answers (1)
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State the demerits of decision tree.
(Solved)
State the demerits of decision tree.
Date posted:
April 13, 2021
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Answers (1)
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A project has the following cash flows
The projects initial cash outlay is Sh 100,000 with a cost of capital of 12%.
Required:
Determine:
(a) The projects expected monetary...
(Solved)
A project has the following cash flows
The projects initial cash outlay is Sh 100,000 with a cost of capital of 12%.
Required:
Determine:
(a) The projects expected monetary value (EMV)
(b) The projects NPV
Date posted:
April 13, 2021
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Answers (1)
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Outline the factors affecting the projects net present value.
(Solved)
Outline the factors affecting the projects net present value.
Date posted:
April 13, 2021
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Answers (1)
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State the advantages of sensitivity analysis.
(Solved)
State the advantages of sensitivity analysis.
Date posted:
April 13, 2021
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Answers (1)
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Outline the steps followed in use of sensitivity analysis.
(Solved)
Outline the steps followed in use of sensitivity analysis.
Date posted:
April 13, 2021
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Answers (1)
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What is sensitivity analysis?
(Solved)
What is sensitivity analysis?
Date posted:
April 13, 2021
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Answers (1)
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State the demerits of certainty equivalent approach.
(Solved)
State the demerits of certainty equivalent approach.
Date posted:
April 13, 2021
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Answers (1)
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State the merits of certainty equivalent approach.
(Solved)
State the merits of certainty equivalent approach.
Date posted:
April 13, 2021
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Answers (1)
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Assume a project costs Sh 30,000 and yields the following uncertain cashflows:
Compute the NPV of the project
(Solved)
Assume a project costs Sh 30,000 and yields the following uncertain cash flows:
Year Cash flow
1 12,000
2 14,000
3 10,000
4 6,000
Assume also that the certainty equivalent coefficients have been estimated as follows:
α0 = 1.00
α1 = 0.90
α2 = 0.70
α3 = 0.50
α4 = 0.30
The risk-free discount rate is given as 10%
Required
Compute the NPV of the project
Date posted:
April 13, 2021
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Answers (1)
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Outline the methods that can be used to incorporate risk into capital budgeting decisions.
(Solved)
Outline the methods that can be used to incorporate risk into capital budgeting decisions.
Date posted:
April 13, 2021
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Answers (1)
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Study the table below and compute the expected cash flow.
(Solved)
Study the table below and compute the expected cash flow.
Date posted:
April 13, 2021
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Answers (1)
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Outline the possible attitudes towards Risk.
(Solved)
Outline the possible attitudes towards Risk.
Date posted:
April 13, 2021
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Answers (1)
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Define the term risk associated with a project.
(Solved)
Define the term risk associated with a project.
Date posted:
April 13, 2021
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Answers (1)
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Project A has the following cashflows over its useful life of 3 years. The market value (Abandonment
value) has also been given.
(Solved)
Project A has the following cashflows over its useful life of 3 years. The market value (Abandonment value) has also been given.
Year Cash Abandonment
flow value
Sh`000' Sh`000'
0 (4,800) 4,800
1 2,000 3,000
2 1,875 1,900
3 1,750 0
Required:
Determine when to abandon the project assuming a discount rate of 10%.
Date posted:
April 13, 2021
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Answers (1)
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Management is faced with eight projects to invest in. The capital expenditures during the year has been rationed to Sh 500,000 and the projects have...
(Solved)
Management is faced with eight projects to invest in. The capital expenditures during the year has been rationed to Sh 500,000 and the projects have equal risk and therefore should be discounted at the firm's cost of capital of 10%.
Required:
Determine the optimal investment sets.
Date posted:
April 13, 2021
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Answers (1)