Financial management revision question and answer

The following six have been submitted for inclusion in 1998 capital expenditure budget for Limuru Ltd.

  Year A

Sh.

B

Sh.

C

Sh.

D

Sh.

E

Sh.

F

Sh.

Investment 0(1998) 250,000 250,000 500,000 500,000 500,000 125,000
  1 0 50,000 175,000 0 12,500 57,500
  2 25,000 50,000 175,000 0 37,500 50,000
  3 50,000 50,000 175,000 0 75,000 25,000
  4

5

50,000

50,000

50,000

50,000

175,000

175,000

0

0

125,000

125,000

25,000
Per year 6 – 9 50,000 50,000   500,000 125,000  
 

Per year

10

11 – 15

50,000

50,000

50,000

50,000

    125,000  
Internal rate    of

return

   

14%

 

?

 

?

 

?

 

12.6%

 

12.0%

Required:
(a) Rates of return (to the nearest half percent) for projects B, C and D and a ranking of all projects in descending order.
(b) Compute the payback reciprocal for projects B and C.
(c) Compute the N.P.V of each project using 16% as discount rate and rank all projects.
answer
(a) I.R.R. for projects B, C and D
Project B
This has 15 years economic life and an annuity of Shs.


From PVAF table at 15 period, a PVAF of 5.000 falls between 18% and 20%


At 5 periods, a PVAF of 2.875 falls between 20% and 24%.
Project D

Computation of I.R.R of a project whose cash flows do not depict any annuity pattern.

We use the weighted average method e.g Project D does not depict any annuity pattern.

Weighted cash inflows:

2.Compute the payback using the weighted average cash flows


3. Determine the approximate rate from the PVIFA tables NPV/16%.

4. Computation of NPV at 16%


(b) Payback reciprocals
Project                                B                                    C


Note: The longer the project life (n>is) the better the payback reciprocals as an estimation of the IRR of a project whose cash flows depict the perfect annuity pattern.

(c) To compute NPV if rate of return is 16% for all project:

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