Sample NPV Questions
Question 1
A two year project costs $500,000. There is a 70% chance that demand will be high in the first year in which case the net cash flow will be $80,000 and a 30% chance it will be low in which case the net cash flow will be -$40,000. If demand is high in the first year there is a 60% chance it will stay high in the second year with net cash flow of $60,000 and a 40% chance it will be low with net cash flow of -$10,000. If demand is low there is a 70% chance it will stay low with net cash flow of -$10,000 and a 30% chance it will be high with net cash flow of $20,000.
Required
If the required return is 10% should the project go ahead? What is the chance of a negative NPV?
Question 2
There is a new product to be manufactured and it has a life of five years. The project requires a land worth $650,000. New machinery with a purchase cost of $360,000 with freight cost of $10,000 and installation cost of $30,000 is needed. Salvage
value is expected to be $50,000 at the end of year 5.
The company plans to borrow the money needed to purchase the machinery from its bank at an interest rate of 6% per annum. It will use retained earnings to fund the purchase of the land and this funding will reduce its dividend payments by $70,000 per year.
EBITDA from operations are expected to be: $350,000; $400,000; $580,000; $400,000; $340,000 respectively.
Working capital requirements are expected to be 10% of EBITDA. Working capital is assumed to be needed at the start of the year. To promote the new product the company will spend $53,000 on direct marketing in the first year.
Should you buy the machine?
QUESTIONS TO ASK YOURSELF:
Can you do the questions?
If not, where are you stuck?
Have you grasp the concept of relevant costs, sunk costs, opportunity costs, incremental costs?
Do you understand the role of depreciation in cash flow?
SMS +65 9758-7925 for tuition! For more information, visit www.tuition.starcresto.com or www.uoltutor.comThe company plans to borrow the money needed to purchase the machinery from its bank at an interest rate of 6% per annum. It will use retained earnings to fund the purchase of the land and this funding will reduce its dividend payments by $70,000 per year.
EBITDA from operations are expected to be: $350,000; $400,000; $580,000; $400,000; $340,000 respectively.
Working capital requirements are expected to be 10% of EBITDA. Working capital is assumed to be needed at the start of the year. To promote the new product the company will spend $53,000 on direct marketing in the first year.
The company’s effective tax rate is 30% and the capital allowances are at 25% of the written down
value of the machinery at the beginning of each year. Any unrelieved capital allowance will be
given in full in the year of disposal. Tax is payable in the same year to which it is related. To keep
things simple assume the net cash flow per year is treated as the taxable profit before capital
allowance.
The after-tax cost of capital for the company is 15%.
The after-tax cost of capital for the company is 15%.
Should you buy the machine?
Question 3
ABC Ltd is considering the purchase of a new photocopying machine
that will enable its photocopy products to be printed with more vibrant colours.
The new machine costing $184,000 is expected to have a useful life of 12
years and be able to be sold at that time for $3,000. ABC Ltd forecasts that the improved quality of its products will
generate an additional $80,000 in revenue in each of the next 12 years. The new machine will also require additional costs in colour toner each
year. These are expected to b $6000 per year.
ABC current printing machine if replaced can be sold for $16,000
today. It has a book value of $10,000 for tax purposes.
The new printing machine will require an additional injection of $5,000
in working capital, which will be recouped at the end of 12 years. In the first
two years additional service costs of $2000 per year will be incurred. These service costs are not tax
deductible. Tax rates are 30% and the required rate of return is 10%. Capital allowances are at 25% of the written down value of the machinery at the beginning of each year. Any unrelieved capital allowance will be given in full in the year of disposal. Tax is payable in the same year to which it is related.
Required:
Calculate the NPV and give your advice as to whether Fine Fabrics Ltd
should proceed and purchase the new machine?
QUESTIONS TO ASK YOURSELF:
Can you do the questions?
If not, where are you stuck?
Have you grasp the concept of relevant costs, sunk costs, opportunity costs, incremental costs?
Do you understand the role of depreciation in cash flow?
