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Chapter 11: Complex Investment Decisions

1.7355
Problem 1

Costs (Rs) NPV PVFA


Year 0 1 2 3 4 10% 10% AEV
Project X 150,000 30,000 30,000 30,000 30,000 245,096 3.1699 77,321
Project Y 75,000 40,000 40,000 144,421 1.7355 83,214
Project Y costs more in terms of annual equivalent value. Hence, Project X should be accepted.

Problem 2

Costs (Rs) NPV NPV


Year 0 1 2 3 4 5 6 7 12% 12%
Project A 150,000 40,000 40,000 40,000 40,000 271,494 3.0373
Project B 200,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 314,094 4.5638
Project B is preferable since its AEV cost is less.

Problem 3

Cash Flows (Rs)


NPV,
Year 0 1 2 3 4 5 6 7 8 12%
Machine P -120,000 42,000 42,000 42,000 42,000 42,000 42,000 52,679
14%
Machine Q -300,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 80,000 71,109
Machine Q is better than P since it has higher AEV cash flows.

Problem 4

Cash Flows (Rs)


PVAF,
Year 0 1 2 3 4 5 NPV, 12% 12% AEV
New machine -150,000 90,000 90,000 80,000 80,000 70,000 149,608 3.6048 41,503
Old machine 0.00 60,000 60,000 60,000 144,110 2.4018 60,000
The firm should not replace the old machine as its AEV cash flows are higher.

Problem 5

Cash Flows (Rs)


PVAF,
Year 0 1 2 3 4 5 NPV, 10% 10% AEV
New machine -300,000 150,000 130,000 120,000 100,000 100,000 64,353 3.7908 16,976
Old machine -60,000 70,000 60,000 90,000 120,841 2.4869 48,592
New and old machines' ending salvage values are included in the last year's cash flows. Rs 60,000 current salvage
value of old machine is its opportunity cost to continue.

Problem 6

Machine X

Year Dep. DTS Repair Op. costs SV NCF


0 -10,000 -20,000 -30,000
1 4,000 1,800 -12,500 -10,700
2 4,000 1,800 -12,500 -10,700
3 4,000 1,800 -12,500 8,000 -2,700
NPV,10% -50,599
PVAF, 10% 2.4869
AEV -20,347
Current salvage value of Rs 20,000 is the opportunity cost of continuing with
machine X, and salvage value ater three years (Rs 8,000) is the opportunity gain of
this decision.

Machine Y
Year Dep. DTS Repair Op. costs SV NCF

0 -45,000 -45,000
1 3,000 1,350 -9,000 -7,650
2 3,000 1,350 -9,000 -7,650
3 3,000 1,350 -12,000 -9,000 -19,650
4 3,000 1,350 -9,000 -7,650
5 3,000 1,350 -9,000 -7,650
6 3,000 1,350 -9,000 -7,650
7 3,000 1,350 -9,000 -7,650
8 3,000 1,350 -9,000 10,000 2,350
NPV,10% -90,163
PVAF, 10% 5.3349
AEV -16,900
Current salvage value of Rs 45,000 is the opportunity cost of continuing with
machine Y, and salvage value after eight years (Rs 10,000) is the opportunity gain
of this decision.

Machine X has higher annual cost than machine Y.

Problem 7
1.
2. There areand
Both old no fixed costs.
new machines operate at full capacity during Sept.-Feb. and at
50% capacity during Mar.-Aug. Thus, production per year is 15,000 units.

3. Cost of capital is assumed to be 10%.

Annual cost if old machines are used:


15,000 Rs 6 = Rs 90,000
Annual cost of production if new machines are used:
15,000 Rs 3 = Rs 45,000
New machines' initial cost is Rs 60,000. AEV of this cost will be:
AEV
60 , 000=
0 .10
AEV =60 , 0000. 10=Rs 6,000
Thus, the annual cost of using new machines is:
Rs 45,000 + Rs 6,000 = Rs 51,000
It is advisable to replace the old machines.

Problem 8

Assumptions
200,000
150,000
dA t ( A t C ) k
=
0.13 dt ( 1ekt )
dA t d ( 200 , 000 ln t )
150,000)* (5) = [(3)/ NPV (6) = = =
dAt/dt
t 0.13 (1 - e-0.13t) (4)] [(2) - (5)] dt dt
1 2 3 4 5 6
3 66,667 9,064 0.3229 28,067 38,600
( A t C ) k ( 200 , 000 ln
=
( 1ekt ) ( 1e0 . 13 t )
=
dt ( 1ekt )
dA t d ( 200 , 000 ln t )
= =
dt dt
( A t C ) k ( 200 , 000 ln
=
4 50,000 16,544 0.4055 40,800 9,200 ( 1ekt ) ( 1e0 . 13 t )
4.5 44,444 19,606 0.4429 44,268 176
5 40,000 22,345 0.4780 46,752 -6,752
6 33,333 27,086 0.5416 50,011 -16,678
7 28,571 31,094 0.5975 52,042 -23,471
The optimum duration is about 4.5 years.

Problem 9

Initial cost 80,000


OCC 10%
NFV 80,000 x (1+t)0.5

Inc. in PVF at
Period, t NFV Value Rate 10% PV NPV

(4) = (6) = [2 x (7) = [(6) -


1 2 3 [3/2] 5 5] 80,000]
1 113,137 - - 0.9091 102,852 22,852
2 138,564 25,427 0.184 0.8264 114,516 34,516
3 160,000 21,436 0.134 0.7513 120,210 40,210
4 178,885 18,885 0.106 0.6830 122,181 42,181
5 195,959 17,074 0.087 0.6209 121,675 41,675
6 211,660 15,701 0.074 0.5645 119,477 39,477
7 226,274 14,614 0.065 0.5132 116,114 36,114

Problem 10

Project Project N
M
Investment 250,000 250,000
Annual cash inflows 80,000 60,000
Cost of capital 10% 10%
Life (yrs) 6 10
PVAF 4.3553 6.1446
PV of cash flows 348,421 368,674
NPV 98,421 118,674
PI 1.39 1.47
AEV 22,598 19,314

Problem 11

Project L Project
M
Year Cash flow Cash
flow
0 -3,000 -3,950
1 2,250 2,700
2 2,700 3,240
NPV, 20% 750 550
PI 1.25 1.14
PVAF 1.528 1.528
AEV 491 360
AEV
89,385
68,824

PVAF,
12% AEV
4.1114 12,813
14%
4.6389 15,329
dA t ( A t C ) k
=
dt ( 1ekt )
dA t d ( 200 , 000 ln t ) 200 , 000
= =
dt dt t
( A t C ) k ( 200 , 000 ln t-150,000 ) 0 . 13
=
( 1ekt ) ( 1e0 . 13 t )
=
dt ( 1ekt )
dA t d ( 200 , 000 ln t ) 200 , 000
= =
dt dt t
( A t C ) k ( 200 , 000 ln t-150,000 ) 0 . 13
=
( 1ekt ) ( 1e0 . 13 t )