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The board of directors of the Kaluma Power Corporation has decided that, for the purpose of testing whether its capital investment projects are acceptable, a compound...

      

The board of directors of the Kaluma Power Corporation has decided that, for the purpose of testing
whether its capital investment projects are acceptable, a compound interest (DCF) rate of 8% per annum
will be used in evaluating investment projects.
All investment project is now under consideration. Estimates of the expected cash flows over forty years, are as follows:
fig21841204.png
The expected residual value of the assets is zero.
Required:
(a) Show whether the project satisfies the normal capital budgeting criteria for acceptance.
(b) Show how sensitive the calculation in (a) above is to:
(i) An increase in the residual asset value from zero to sh.1,000,000.
(ii) A 1% increase in the initial capital outlay (during each year of the outlay).
(iii) A 1% decrease in the estimate of expected cash flow during each of the years from 6 to 10.
(c) Show the effect of adopting the project on the ratio of reported profits in years 5 and 6 to net
balance sheet value of assets at the beginning of those two years. Comment briefly on the usefulness
of the latter type of ratio in the interpretation of accounts in the light of your calculation. (Assume
that the expenditure in years 1 to 5 is capitalized, that straight-line depreciation is charged after year 5 at 5% per annum, and the actual cash flows are according to plan).
You can assume that all cash flows arise on the last day of each year, that all figures are net of tax
and expressed in terms of constant price levels, and that working capital for the investment project
can be ignored.

  

Answers


Kavungya
fig31841205.png
Kavungya answered the question on April 17, 2021 at 21:05


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