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UBFF2013 BUSINESS FINANCE (MAY 2015)

UNIVERSITI TUNKU ABDUL RAHMAN


FACULTY OF BUSINESS AND FINANCE
ACADEMIC YEAR 2015 / 2016
TUTORIAL 9
Learning Outcome:On completion of this unit, a student shall be able to:

Explain the role of capital budgeting techniques in the capital budgeting process.
Calculate, interpret and evaluate payback period, net present value, profitability index
and internal rate of return.

9-1

What are the most commonly used capital budgeting procedures?


Why is capital-budgeting decision so important? Why are capital-budgeting errors so
costly?

9-2

The treasurer of Anthony Press. has projected the cash flows of projects A, B, and C
as follows. The required rate of return on both projects is 12 %.
Year
0
1
2

Project A
(RM100,000)
70,000
70,000

Project B
Project C
(RM200,000) (RM100,000)
130,000
75,000
130,000
60,000

a. Compute the profitability indices for each of the three projects.


b. Compute the NPV for each of the three projects.

c. Suppose these three projects are independent. Which project (s) should
Anthony accept based on the profitability index rule?
9-3

Jojo is reviewing a project with an initial cash outflow of RM250,000. An additional


RM100,000 will have to be invested after the first year, followed by an additional
investment of RM50,000 at the end of the second year. Beginning at the end of year
three, the project is expected to generate cash flows of RM90,000 per year for the
next eight years. Calculate the projects payback period, net present value (NPV), and
internal rate of return (IRR) at a cost of capital of 8 percent.

Year

Cash Flows

Cumulative
1

UBFF2013 BUSINESS FINANCE (MAY 2015)

0
1
2
3
4
5
6
7
8
9
10
9-4

(RM)
(250,000)
(100,000)
(50,000)
90,000
90,000
90,000
90,000
90,000
90,000
90,000
90,000

(250,000)
(350,000)
(400,000)
(310,000)
(220,000)
(130,000)
(40,000)
50,000

Lesley Sdn. Bhd. is attempting to evaluate the feasibility of investing RM95,000 in a


piece of equipment that has a 5-year life. The firm has estimated the cash inflows
associated with the proposal as shown in the table. The firm has a 12% cost of capital
Year (t)
1
2
3
4
5

Cash inflows (CFt)


RM20, 000
25,000
30,000
35,000
40,000

(i) Calculate the payback period


(ii) Calculate the net present value (NPV)
(iii)

Calculate the internal rate of return (IRR)

(iv)Evaluate the acceptability of the proposed investment using NPV and


IRR. What recommendation would you make relative to implementation
of the project? Why?

9-5

Valley Products, Inc. is considering two independent investments having the


following cash flow streams:
Year

Project A

Project B

-$50,000

-$40,000

+20,000

+20,000

+20,000

+10,000

+10,000

+5,000
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UBFF2013 BUSINESS FINANCE (MAY 2015)

+5,000

+40,000

+5,000

+40,000

Valley uses a combination of the net present value approach and the payback
approach to evaluate investment alternatives. It requires that all projects have a
positive net present value when cash flows are discounted at 10 percent and that all
projects have a payback period no longer than 3 years. Which project or projects
should the firm accept? Why?