Question

a) A piece of equipment costing K10,000 has an expected life of 5 years. It is estimated that the cash now resulting from the use of this machine will be K4, 000 per year. The rate of return expected from the capital of this type is fifteen percent. Required: Calculate the following: i. ii. iii. The payback period. The net present value The internal rate of return 2 marks 5 marks 5 marks b) A firm is faced with two alternative investment plans. Plan A will cost K750 and plan B K940. Both plans involve purchase of equipment the life of which is four years. It is estimated that the cash flows during that time will be: Year 1 2 3 Plan A 300 400 400 300 300 Plan B 500 Given that the firm expects a return of 20 per cent on capital employed, which plan recommend? 6 marks c) How much must be invested now if you require K12, 500 in five years' time and if nu can be invested at 10 per cent per annum? 2 marks

Answer 1

1) a) i) Payback period is determined by Net Cash outflows / Cash in flows per year. K10,000 / K4000 = 2.5 years.

1) a) ii) Discounting rate of 15% is used to work out the NPV. NPV is the sum total of all the cash flows expected through out the life of the asset. Year 1 cash outflows = -10,000, Year 1 cash inflows = 4000 / (1+0.15) = 3478, Year 2 Cash flows = 4000 / (1+0.15)^2 = 3025, Year 3 Cash flows = 4000 / (1+0.15)^3 = 2,632, Year 4 Cash flows = 4000/ (1+0.15)^4 = 2286, Year 5 cash flows = 4000 / (1+0.15)^5 = 1989. Adding up all the cash-flows, the NPV = K3,410

1) a) iii) IRR is a rate at which cash-inflows and cash-outflows equals.

0 = -10,000+ 3478/(1+IRR)^1+ 3025/(1+IRR)^2 + 2632 / (1+IRR)^3+2286 / (1+IRR)^4 + 1989 / (1+IRR)^5

IRR = ~12%

2) NPV is the best indicator on which plan will be beneficial. Discount rate of 20% could be used to compute NPV.

Plan B is recommended given higher NPV v/s Plan A. Workings are below.

Plan A provides NPV of 47.8

Cash Outlay		-750.0
Yearly inflows	Discount Factor	Discounted Cash Flow
300	0.833333	250.0
400	0.694444	277.8
300	0.578704	173.6
200	0.482253	96.5
	NPV	47.8

Plan B provides NPV of 72.7

Cash Outlay		-940.0
Yearly inflows	Discount Factor	Discounted Cash Flow
500	0.833333	416.7
400	0.694444	277.8
300	0.578704	173.6
300	0.482253	144.7
	NPV	72.7

c) Will be answered seperately. In a multiple question, per the guidelines upto 4 questions can be answered. Four questions are already answered for this multiple question.