Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

You have been provided with the following information about a project, which XYZ Ltd. is planning to undertake soon.

Required:
(a) Calculate the project‟s net investment.

(b) Using the net present value method, show whether or not the project should be undertaken the company.

(c) Suppose in addition to the information given above you are provided with the following cash flows certainty equivalents:

Year 0: 1.00
Year 1: 0.90
Year 2: 0.80
Year 3: 0.60
Year 4: 0.50
Year 5: 0.40

Does your conclusion about the acceptability of the project in part (c) above change? Explain.
ANSWER
(a) Projects Net Investment

Initial outlay = Purchase Cost + Installation Cost + Working Capital
= 760,000 + 65,000 (initial cost) + 185,000
= 825,000 + 185,000
= 1,010,000

Conclusion is that the acceptability of the project changes as NPV turns to negative (i.e Ksh.140,041). The problem would arise in either determination of the risk adjusted discount rate on certainty equivalent, otherwise the 2 approaches should provide consistent results.

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