Advanced financial management revision question and answer

Advanced Financial Management Block Revision Mock Exams

a) Briefly explain the importance of sensitivity analysis, with specific reference to investment appraisal under uncertainty.
b) A company is considering whether it is necessary to purchase equipment to increase its production and sales volumes. The equipment costs Sh.500,000 and has a useful life of three years after which it can be sold as scrap for Sh.80,000. For each of the three years of usage, the equipment is expected to increase both sales revenue and operating costs Sh.600,000 and Sh.390,000 respectively. The company’s cost of capital is 10%

Required:

i) Calculate the project‟s net present value (NPV) (2 marks)
ii) Compute the percentage changes required in the cost of the equipment, the scrap value and the sales revenue for the project to be rejected.

c) Mr. Charles Kabazi has a capital of Sh.1,000,000 which he wishes to invest in three sectors of the economy; agriculture, service and manufacturing. The funds will be allocated as follows:

Details on the possible future economic states, their probabilities of occurrence and the expected return for each of the sectors are presented below:

Required:

i) Determine the risk associated with the investment in each of the three sectors above.
ii) Determine the expected portfolio return
ANSWER

a) Sensitivity analysis – a method of assessing risk in long term projects in which the effects of changes Cashflows, initial capital, economic life etc affecting the project.

– A range of figures for various estimates may be considered to establish whether a positive or negative NPV results
b) in projects viability (planned outcome) are evaluated as a result of changes in critical variables eg.


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