FM – Ch- 4, 5

DEF Co has a cost of capital of 12%.

Project A has a positive NPV of $5,000 when discounted at 12% and a positive NPV of $3,600 when discounted at 16%.

Project B has a positive NPV of $8,000 when discounted at 12% and a negative NPV of $1,000

when discounted at 16%.

The projects are mutually exclusive.

Required

Q. What is the internal rate of return for projects A and B?

• Project A has an IRR of 26.3% and B an IRR of 16.5%.

• Project A has an IRR of 26.3% and B an IRR of 15.6%.

• Project A has an IRR of 11+.3% and B an IRR of 16.5%.

• Project A has an IRR of 11+.3% and B an IRR of 15.6%.

DEF Co has a cost of capital of 12%.

Project A has a positive NPV of $5,000 when discounted at 12% and a positive NPV of $3,600 when discounted at 16%.

Project B has a positive NPV of $8,000 when discounted at 12% and a negative NPV of $1,000

when discounted at 16%.

The projects are mutually exclusive.

Required

Q. Which of the following statements is correct?

• Both NPV and IRR indicate that Project A is the more financially viable project.

• In order to maximise shareholder wealth Project A is the better project.

• Neither Project A nor Project B should be accepted from a financial perspective.

• Project B will increase shareholder wealth more than Project A at the current cost of capital.

Bistro Co is a brewing company trying to decide whether to buy a new bottling machine for $10m to save on rental costs which are currently $6.6m p.a.

Running costs for the new machine would be $1.2m p.a.

The bottling machine has no resale value and has an expected life of three years.

All cash flows are quoted in current prices (i.e. in real terms) and are expected to rise in line with the consumer price index (or CPI, a measure of inflation) at 5.26% p.a.

Bistro's real cost of capital is 14%, and its nominal cost of capital is 20%. Ignore tax.

Required

Q. Evaluate whether the new bottling machine should be purchased.

• Yes – NPV = +3.54

• Yes – NPV = +2.54

• No

• Yes

SW Co has a 31 December year end and pays corporation tax at a rate of 30%, 12 months after the end of the year to which the cash flows relate. It can claim tax-allowable depreciation at a rate of 25% reducing balance. It pays $1m for a machine on 31 December SW Co's cost of capital is 10%.

What is the present value on 31 December of the benefit of the first portion of tax-allowable depreciation?

• $250,000

• $227,250

•   $68,175

• $75,000

A company receives a perpetuity of $20,000 per year in arrears, and pays 30% corporation tax 12 months after the end of the year to which the cash flows relate. At a cost of capital of 10%, what is the after-tax present value of the perpetuity?

• $140,000

• $145,454

• $144,000

• $127,274

A project has the following projected cash inflows.

Year 1 - $100,000

Year 2 - $125,000

Year 3 - $105,000

Working capital is required to be in place at the start of each year equal to 10% of the cash inflow for that year. The cost of capital is 10%.

What is the present value of the working capital?

• $Nil

• -$30,036

• -$2,735

• $33,000

AW Co needs to have $100,000 working capital in place immediately for the start of a 2- year project. The amount will stay constant in real terms. Inflation is running at 10% per year, and AW Co's money cost of capital is 12%.

What is the present value of the cash flows relating to working capital?

• -$21,260

• -$20,300

• -$108,730

• -$4,090

NCW Co is considering investing $10,000 immediately in a I-year project with the following cash flows.

Income - $100,000

Expenses - $35,000

The cash flows will arise at the end of the year. The above are stated in current terms. Income is subject to 10% inflation; expenses will not vary. The real cost of capital is 8% and general inflation is 2%.

Using the money cost of capital to the nearest whole percentage, what is the NET present value of the project?

• $68,175

• $60,190

• $58,175

• $78,175

AM Co will receive a perpetuity starting in 2 years' time of $10,000 per year, increasing by

the rate of inflation (which is 2%).

What is the present value of this perpetuity assuming a money cost of capital of 10.2%?

• $90,910

• $125,000

• $115,740

• $74,403

FW Co is expecting a receipt of $10,000 (in real terms) in 1 years’ time.

If FW Co expects inflation to increase, and receipts are expected to rise in line with the general rate of inflation, what impact will this have on the present value of that receipt?

• Nil

• Reduce

• Increase

• Cannot say