Sei sulla pagina 1di 14

Corporate Finance

Tutorial 1 Suggested Solutions

Corporate Finance
Tutorial 1: Time Value of Money and Project Appraisal
Suggested Solutions
Solutions to Exercises on Time Value of Money
A1.
(a)

i compounded annually
PV(Bid)

= PV(FB)
= $5,000,000 PVIF 20%,5
= $5,000,000 (0.4019)
= $2,009,500

(b)

i compounded semi-annually
PV(Bid)

= $5,000,000 PVIF 10%,10


= $5,000,000 (0.3855)
= $1,927,500

(c)

i compounded quarterly
PV(Bid)

= $5,000,000 PVIF 5%,20


= $5,000,000 (0.3769)
= $1,884,500

A2.

Method 1
$20,000 = (PMT) PVIFA 12%,5
PMT

$20,000
3.6048

= $5,548.16 per annum


!

= $462.35 per month

Impact Consultancy & Training Pte Ltd

Corporate Finance

Tutorial 1 Suggested Solutions

Method 2
$20,000 = (PMT) PVIFA 1%,60
PMT

$20,000
45

= $444.44 per month


A3.

Plan X
Yr

CF

75,000

Interest Factor
1

PV (CF)
75,000

1
2

7,500

PVIFA 3,10%

18,651.75

PVIF 3,10%

18,782.50

3
3

25,000

4
5
6
7
8

PVIFA 12,10%
9,000

x PVIF 3,10%

46,072.20

(15,000)

PVIF 15,10%

(3,591)

9
10
11
12
13
14
15
15

PV (Cost)
Impact Consultancy & Training Pte Ltd

$154,915.45
2

Corporate Finance

Tutorial 1 Suggested Solutions

Plan Y
Yr

CF

Interest Factor

PV (CF)

30,000

4,500

PVIFA 5,10%

17,058.60

40,000

PVIF 5,10%

24,836

6,000

PVIF 6,10%

3,387

9,500

PVIFA 9,10%
x PVIF 6,10%

30,884.50

30,000

1
2
3
4
5

7
8
9
10
11
12
13
14
15
10

40,000

PVIF 10,10%

15,420

15

(30,000)

PVIF 15,10%

(7,182)

PV (Cost)

114,404.10

The revenue aspect of this project is assumed to be the same regardless of which plan is
adopted. Hence, the decision rest on which plan is effectively cheaper.
PV (Costs) of Plan Y < PV (Costs) of Plan X
Impact Consultancy & Training Pte Ltd

=>

Plan Y is preferred.

Corporate Finance

Tutorial 1 Suggested Solutions

Solutions to Exercises on Net Present Value


A1.

NPV = $1,000 PVIFA5%,6 $5,000


= ($1,000 x 5.0757) $5,000
= $75.70
(Accept)

A2.

NPV = [600 PVIF5%,1 + 300 PVIF5%,2 + 300 PVIF5%,3] 1,000


= [(600 x 0.9524) + (300 x 0.9070) + (300 x 0.8638)] 1,000
= 102.69
(Accept)

A3.

NPV = [6,000 PVIF5%,1 + 4,000 PVIF5%,2 + 2,000 PVIF5%,3] 10,000


= [(6,000 x 0.9524) + (4,000 x 0.9070) + (2,000 x 0.8638)] 10,000
= 1,070
(Accept)

A4.

NPV = [1,000 PVIFA5%,2 + 1,500 (PVIFA5%,3)(PVIF5%,2)] [1,500 +


2,000 PVIF5%,2]
= [(1,000 x 1.8594) + (1,500 x 2.7232 x 0.9070)] [1,500 +
(2,000 x 0.9070)]
= 2,250.26 (Accept)

Impact Consultancy & Training Pte Ltd

Corporate Finance

Tutorial 1 Suggested Solutions

Solutions to Sample Examination Questions for Chapter 1


A1.
Year

Cash Flow ($)

PV Factor

PV of CF ($)

(1,000,000)

1.0000

(1,000,000)

200,000

0.9091

181,820

190,000

0.8264

157,016

180,500

0.7513

135,610

171,475

0.6830

117,117

162,901

0.6209

101,145

154,756

0.5645

87,360

147,018

0.5132

75,450

140,000

0.4665

65,310

140,000

0.4241

59,374

10

140,000

0.3855

53,970

NPV

34,172

As NPV is positive, Toyundai should take on the investment. It is expected to


enhance the value of the firm.
A2.

Payback elaborate on the following weaknesses

Ignore time value of money

Bias against projects with late cash flows

Not a profit measure

Accounting Rate of Return (ARR) elaborate on the following

Ignore timing of cash flows as it uses accounting profits

Ignore time value of money

Average investment is ambiguous

Impact Consultancy & Training Pte Ltd

Corporate Finance

Tutorial 1 Suggested Solutions

Suggested Solution to Lee Ltd


a)
2-Year Alternative
40
20
20
40
40 ................................... 40
|-------------------------------------------------------------------|
0
1
2
3
4 ................................... 22
(140) (140)
NPV = 20 PVIF7%,1 + 60PVIF7%,2 + 40 PVIFA7%,20 PVIF7%,2
140 (PVIF7%,1 + PVIF7%,2)
= (20 x 0.9346) + (60 x 0.8734) + (40 x 10.5940 x 0.8734) (140)(0.9346 +
0.8734)
= 188.09k
5-Year Alternative
20 ..... 20
40 ................................... 40
|-----------------------------------------------------------|
0
1 ....... 5
6 .................................... 25
(40) .... (40)
NPV = 40 PVIFA7%,20 PVIF7%,5 20 PVIFA7%,5
= (40 x 10.5940 x 0.7130) (20 x 4.1002)
= 219.84k

Impact Consultancy & Training Pte Ltd

Corporate Finance

b)

c)

Tutorial 1 Suggested Solutions

The assumptions on which the calculations in part (a) were based on are:

Cost of Capital of 7% as the discount rate is reasonable as it represents the


company's opportunity cost of capital i.e. the return foregone by committing
the financial resources to the project.

The assumption of a constant discount rate may not reflect the interest rate
risk. However, as it is not possible to predict future levels of interest rate with
pinpoint accuracy, it would be fair to assume constant given an existing
capital structure and the cost of its respective sources of capital provided the
risk of interest rate fluctuations is incorporated.

Although cash flows in a project usually occur evenly each year but to
simplify calculations they are assumed to occur at a particular point in time.
The end of the year assumption effectively only caused the calculation to be
more conservative.

Sale of the product is assumed to be comfortably above the units to be


produced by the new plant. As such no revenue effect is taken into
consideration in the analysis. Otherwise, the analysis must consider the
possibility of sales volume being lower than the number of units that can be
produced.

Assume 10% lower in the new contribution.


2-Year Alternative
NPV lower by (36 40)(PVIFA7%,20 )(PVIF7%,2)
= 4 x 10.5940 x 0.8734
= 37.01k
5-Year Alternative
NPV lower by (36 40)(PVIF7%,20)(PVIF7%,5)
= 4 x 10.5940 x 0.7130
= 29.92k

Impact Consultancy & Training Pte Ltd

Corporate Finance

Tutorial 1 Suggested Solutions

Assume 10% increase in construction cost.


2-Year Alternative
NPV lower by (140 154) (PVIF7%,1 + PVIF7%,2)
= 14 x (0.9346 + 0.8734)
= 25.31k
5-Year Alternative
NPV lower by (40 44)(PVIFA7%,5)
= 4 x 4.1002
= 16.4k
As per above calculation, the most sensitive variable is the contribution from the
new plant.

Impact Consultancy & Training Pte Ltd

Corporate Finance

Tutorial 1 Suggested Solutions

Suggested Solutions to FE2007 Zone B Question B6(a)


NPV-Rule

Measures the immediate increase in wealth, which results from the


adoption of a project when discounted at the companys cost of capital.
Gives most reliable advice for accept/reject decisions.
Allows for the time value of money.
NPVs are additive. That is the total benefit of a number of projects, which
can be obtained by summing the individual NPVs to give a total value for
wealth increase.
NPV is sometimes criticized on the basis that non-financial managers find
it difficult to comprehend and find IRR and payback rules easier to relate
to.

Internal Rate of Return (IRR) - Rule

Give a rate of interest over the life of the project which can be compared
with the companys cost of capital.
In most accept/reject decisions, advice given by IRR will coincide with
that given by NPV. However, IRR has technical problems where there are
unconventional cash flows (multiple IRRs) and may give incorrect advice
where a choice has to be made between mutually exclusive projects.
IRR is often favoured over NPV in practice because, as mentioned above,
businessmen find it easier to relate to.

Payback rule

Measures how long (usually how many years) the project will take to pay
back the initial investment.
This method is often favoured by businessmen because it is claimed that it
emphasizes liquidity and makes an intuitive allowance for risk. It is also
simple to use and easy to understand.
However, use of payback alone can lead to the selection of unprofitable
projects.
No recognition is given to the time value of money.
Cash flows receivable after the payback period are ignored.
Risk is related to the speed of payback which may not be realistic.
The use of payback will tend to favour short-term projects, which may
lead to the adoption of unprofitable or low profit short-term projects and
the exclusion of long-term profitable ones.

Impact Consultancy & Training Pte Ltd

Corporate Finance

Tutorial 1 Suggested Solutions

Suggested Solutions to FE2009 Zone B Question A3(a)


NPV (Model A) = -200 + 90PVIF1.10 + 70PVIF2.10 + 110PVIF3.10
= -200 + 90(0.9091) + 70(0.8264) + 110(0.7513)
= -200 +81.82 + 57.85 + 82.64
= 22.31
NPV (Model B) = -200 + 190(0.9091) + 55(0.8264)
= -200 + 172.73 + 45.45
= 18.18
If neither of the project can be repeated, one should choose the project with the
higher NPV. Otherwise, to choose the project to make more economic sense
assuming both can be repeated at the end of its useful life, Annual Equivalent
Value (AEV) approach is preferred.

AEV (Model A) =

AEV (Model B)
!

NPV 22.31
=
= 8.97
A3.10 2.4868

18.18
= 10.48
1.7355

Hence, if both models can be repeated in the foreseeable future, Model B is more
economical.
!

Impact Consultancy & Training Pte Ltd

10

Corporate Finance

Tutorial 1 Suggested Solutions

Suggested Solution to FE2010 Zone B Question A3


(a)

Cost of
machine

(1,200,000)

Expected annual
Contribution (1)

903,600

936,000

972,000

1,044,000

Modification
Cost (2)
_________

(50,000)

_______

_________

NCF before
tax

(1,200,000)

853,600

936,000

972,000

1,044,000

Tax (3)

__________

(166,080)

(213,300)

(240,975)

(161,325)

NCF
after tax

(1,200,000)

687,520

722,700

731,025

882,675

DF @ 15%

_________

0.870

0.756

0.658

0.572

PV (NCF)

(1,200,000)

598,592.40

546,361.20

NPV

481,014.45

504,890.10

$930,408.15

Impact Consultancy & Training Pte Ltd

11

Corporate Finance

Tutorial 1 Suggested Solutions

Note (1)
(i)

Depreciation expense = 1,200,000 = 30,000/year


4
= 10 per unit/year

(ii)

Unit production cost :


Material
Labour
OH (inclusive of Dep)
Less: Dep exp/unit

(iii)

Net unit contribution :


Selling price
Unit production
Net Contribution
per unit

(iv)

8
6
20
(10)
24

60
(24)
36

Expected net annual contribution :


Y1

Y2

Y3

Y4

Expected demand units

25,100

26,000

27,000

29,000

Net unit contribution ()

36
________

36
_______

36
_______

36
_______

936,000

972,000

1,044,000

Net annual contribution () 903,600


Note (2)
Cost of modification

= 50,000

If modification is done at the beginning of Yr 2 (ie. End of Yr 1) :


PV1 (Cost of modification)

Impact Consultancy & Training Pte Ltd

= 50,000

12

Corporate Finance

Tutorial 1 Suggested Solutions

PV1 (Future Benefits)

= 0.30 (2,000 x 36) + 0.3 (5,000 x 36) + 0.3(10,000 x 36)


1.15
(1.15)2
(1.15)3
= 18,782.61 + 40,831.76 + 71,011.75
= 130,626.12

NPV1 (in Yr1)

130,626.12 50,000

= 80,626.12

If modification is done at the beginning of Yr 3 (ie. End of Yr 2) :


PV1 (Cost of modification) = 50,000 = 43,478.26
1.15
PV1 (Future benefit)

= 40,831.76 + 71,011.75
= 111,843.51

NPV1 (in Y2)

= 111,843.51 43,478.26 = 68,365.25

If modification is done at the beginning of Yr 4 (ie. End of Yr 3) :


PV1 (Cost of modification) = 50,000 = 37,807.18
(1.15)2
PV1 (Future benefit)

= 71,011.75

NPV1 (in Y2)

= 71,011.75 37,807.18 = 33,204.57

Implementation of modification is better as NPV of such decision generates


the value to company. This value is maximized if it is done at the beginning of
Yr2.
Note (3)
(i)

Capital Allowance :
0

Written Down
Value
1,200,000

900,000

675,000

506,250

Capital Allowance
(25%)

300,000

225,000

168,750

Impact Consultancy & Training Pte Ltd

4___

506,250

13

Corporate Finance

(ii)

Tax Expense :
Pre-tax profit
Before Capital
Allowance

(b)

Tutorial 1 Suggested Solutions

853,600

936,000

972,000

1,044,000

Capital Allowance (300,000)

(225,000)

(168,750)

(506,250)

Pre-tax profit
After Capital
Allowance

553,600

711,000

803,250

537,750

Tax (30%)

166,080

213,300

240,975

161,325

To elaborate on the following:


(i) To discuss briefly each of the different methods of project appraisal:
Payback (PB), Accounting Rate of Return (ARR), Net Present Value
(NPV), Internal Rate of Return (IRR) and Profitability Index (PI).
(ii) To focus on assessing NPV and IRR techniques in project appraisal:
Problems with IRR and how NPV is superior to IRR as it can deal with
all types of cash flows (conventional and non-conventional) and can
take into account of the size and magnitude of the projects being
appraised, enabling easy comparison. It can also be used with other
techniques such as PI and annual equivalent value. IRR assumes that
spare cash flows from a project can be re-invested at the IRR, which is
not always the case. NPV does not have this conceptual problem.

Impact Consultancy & Training Pte Ltd

14

Potrebbero piacerti anche