Assignment 1 (14.

12)
High demand
Profit = 1500000 +300000
Profit = 1800000.

Low demand
Profit = 600000 + 300000
Profit = 900000.
0.60

1800000

HD
Small
Premises LD
0.40

900000

0.75

1800000

HD
Large
Premises LD
0.25

900000

K
= (1800000*0.60) + (900000*0.40) = 1440000
(small premises without information)
K
= (1800000*0.75) + (900000*0.25) = 1575000
(large premises without information)

(Large premises must be built).

K
= (1800000*0.95) + (900000*0.05) = 1755000
(large premises with information)
Firlands Ltd. can pay for survey maximum = (1755000-1575000) =
180000
Firlands can conduct the survey.
So large premises will be built.

Assignment - 2
(SAP Ltd.)
(a)

Why is the investment appraisal so important?

Ans:

(b)
What is the payback period of each project? If SAP Ltd
imposes a three year maximum payback period which of these
projects should be accepted?
Ans:

YEAR-1
Payback of
A

20000

YEAR-2
50000

YEAR-3
90000

YEAR-4
(12*20000)/500
00
= 4.8
( 5 months
app.)

In case of project A payback period is 3 years and 5 months.

Payback of
B

YEAR1

YEAR2

40000

80000

YEAR-3
(12*30000)/400
00
= 9 months

In case of project B payback period is 2 years and 9 months.

Project B should be accepted since there is 3 year maximum

payback period.

(c) What are the criticisms of the payback period?

Ans: Payback method does not consider any cash flow. Payback
method does not take into account the cost of capital and time
value of money.
(d) Determine the NPV of these projects. Should they be acceptedexplain why.
Ans:

Project A
PV1 = (20000) (1+0.12)1 = 17857.14
PV2 = (30000) (1+0.12)2 = 23915.82
PV3 = (40000) (1+0.12)3 = 21353.41
PV4 = (50000) (1+0.12)4 = 31775.90
PV5 = (70000) (1+0.12)5 = 39719.88
_______________________________
PV of FCF = 134622.15
NPVA= (134622.15-110000) = 24622.15

Project B
PV1 = (40000) (1+0.12)1 = 35714.29
PV2 = (40000) (1+0.12)2 = 31887.76
PV3 = (40000) (1+0.12)3 = 28471.21
PV4 = (40000) (1+0.12)4 = 25420.72
PV5 = (40000) (1+0.12)5 = 22697.07
_______________________________
PV of FCF = 114191.05
NPVB= (114191.05-110000) = 4191.05
A and B have positive NVPs. So they should be accepted.
(e) Describe the logic behind the NPV approach.
Ans:
Using NPV we can overcome the limitations that we face in ARR.
Cost of capital and time value of money is included in NPV. If the
rate of return is lower, NPV will be negative. NPV will be positive if
rate of return is higher. A positive NPV means a project should be

accepted, and rejected if NPV is negative. A zero NPV indicates that

the firm should be indifferent to whether the project is accepted or
rejected.
(f) What would happen if: (1) the required rate of return increased?
(2) the required rate of return decreased?
Ans:
1. If the required rate of return is increased, then NPV will
decrease.
2. If the required rate of return is decreased, then NPV will
increase.
(g) Determine the IRR for each project. Should they be accepted?
Ans:

Finding IRRA
PVIFA

IRR, n

= 110000 42000 = 2.619

Approximate IRR = 27%

LR = 20%
NPV@ LR = (20000 PVIF20%,1 + 30000 PVIF20%,2 + 40000
PVIF20%,3 + 20000 PVIF20%,4 + 20000 PVIF20%,5 ) 110000
= (112894-110000)
= 2894
HR = 21%
NPV@ HR = (20000 PVIF21%,1 + 30000 PVIF21%,2 + 40000
PVIF21%,3 + 20000 PVIF21%,4 + 20000 PVIF21%,5 ) 110000
= (109908-110000)
= 92

IRRA = 20% + (28942894+92) 1%

IRRA = 20.97%
Finding IRRB

PVIFA

IRR, n

= 110000 40000 = 2.75

Approximate IRR = 24%

LR = 23%
NPV@ LR = 40000 (PVIF23%,1 + PVIF23%,2 + PVIF23%,3 + PVIF23%,4 +
PVIF23%,5 )
- 110000
= (112260-110000)
= 2260
HR = 24%
NPV@ HR = 40000 (PVIF24%,1 + PVIF24%,2 + PVIF24%,3 + PVIF24%,4 +
PVIF24%,5 )
- 110000
= (109820-110000)
= 180
IRRB = 23% + {2260(2260+180)} 1%
IRRB = 23.93 %

IRRA and IRRB are greater than k. So the projects should be

accepted.
(h) How does a change in the required rate of return affect the
projects IRR?
Ans:
When k is increased, NPV decreases. Thus IRR decreases.
When k is decreased, NPV increases. Thus IRR increases.

(i) Why is the NPV approach often regarded to be superior to the IRR
method?
Ans:

Using NPV method we accept a project with a positive NPV and

reject one with negative NPV. But we cant do the same in IRR
method. IRR of a project can be greater than k where we can accept
the project. But if there are two projects greater than k we dont
know which one to choose. So the NPV method often regarded to be
superior to the IRR method