PFM 4-1

115. Apollo company is considering investing in a two-year project. Machine set-up costs will be $125,000, payable immediately. Working capital of $4,000 is required at the beginning of the contract and will be released at the end.

Given a cost of capital of 10%, what is the minimum acceptable contract price (to the nearest thousand dollar) to be received at the end of the contract?

116. Which TWO of the following statements are correct?

117. PV Co has a barrel of chemicals in its warehouse that it purchased for a project a while ago at a cost of $1,000. It would cost $400 for a professional disposal company to collect the barrel and dispose of it safely. However, the chemicals could be used in a potential project which is currently being assessed. What is the relevant cost of using the chemicals in a new project proposal?

118. Which of the following is a drawback of the payback period method of investment appraisal?

The following information relates to questions 119 and 120.

Semco Co is considering investing $46,000 in a new delivery lorry that will last for 4 years, after which time it will be sold for $7,000. Depreciation is charged on a straight-line basis. Forecast operating profits/(losses) to be generated by the machine are as follows.

119. What is the return on capital employed (ROCE) for the lorry (using the average investment method, to the nearest %)?

120. Assuming operational cash flows arise evenly over the year, what is the payback period for this investment (to the nearest month)?

121. QW is considering a project which has an initial outflow followed by several years of cash inflows, with a cash outflow in the final year. How many internal rates of return could there be for this project?

122. Jelly Co wishes to undertake a project requiring an investment of $732,000 which will generate equal annual inflows of $146,400 in perpetuity. If the first inflow from the investment is a year after the initial investment, what is the IRR of the project?

123. LW Co has a half empty factory on which it pays $5,000 pa rent. If it takes on a new project, it will have to move to a new bigger factory costing $17,000 pa and it could rent the old factory out for $3,000 pa until the end of the current lease. What is the rental cost to be included in the project appraisal?

124. An accountant is paid $30,000 per year and spends 2 weeks working on appraising project Alpha. Why should the accountant NOT charge half of her month’s salary to the project?

125. Swap has 31 December as its accounting year end. On 1 January 20X5 a new machine costing $2,000,000 is purchased. The company expects to sell the machine on 31 December 20X6 for $350,000.

The rate of corporation tax for the company is 30%. Tax-allowable depreciation is obtained at 25% on the reducing balance basis, and a balancing allowance is available on disposal of the asset. The company makes sufficient profits to obtain relief for tax-allowable depreciation as soon as they arise. If the company’s cost of capital is 15% per annum,

What is the present value of the tax savings from the tax-allowable depreciation at 1 January 20X5 (to the nearest thousand dollars)?

126. A company has a ‘money’ cost of capital of 20% per annum. The inflation is currently estimated at 7% per annum. What is the ‘real’ cost of capital (to the nearest whole number)?

127. Four mutually exclusive projects have been appraised using net present value (NPV), internal rate of return (IRR), return on capital employed (ROCE) and payback period (PP). The company objective is to maximise shareholder wealth. Which should be chosen?

128. A person has won first prize in a national competition and they have a choice as to how they take the prize: Option 1 Take $90,000 per year indefinitely starting in 3 years’ time (and bequeath this right to their children and so on); or Option 2 Take a lump sum of $910,000 in 1 year’s time. Assuming a cost of capital of 10%, which would you advise and why?

129 .A project has an initial outflow followed by years of inflows. What would be the effect on NPV and the IRR of an increase in the cost of capital? Match the technique described to the expected impact from this increase.

A. NPV

B. IRR

130. Which TWO of the following are advantages of the IRR?

131. Arnold is contemplating purchasing for $280,000 a machine which he will use to produce 50,000 units of a product per annum for five years. These products will be sold for $10 each and unit variable costs are expected to be $6. Incremental fixed costs will be $70,000 per annum for production costs and $25,000 per annum for selling and administration costs. Arnold has a required return of 10% per annum.

By how many units must the estimate of production and sales volume fall for the project to be regarded as not worthwhile?

132. Williams Ltd plans to purchase a machine costing $18,000 to save labour costs. Labour savings would be $9,000 in the first year and labour rates in the second year will increase by 10%. The estimated average annual rate of inflation is 8% and the company’s real cost of capital is estimated at 12%. The machine has a two year life with an estimated actual salvage value of £5,000 receivable at the end of year 2. All cash flows occur at the year end. What is the negative NPV (to the nearest $10) of the proposed investment?

133. A lease agreement has an NPV of ($26,496) at a rate of 8%. The lease involves an immediate down payment of $10,000 followed by 4 equal annual payments. What is the amount of the annual payment?

134. Smith plans to buy a bungalow in five years’ time for cash. He estimates the cost will be $1.5m. He plans to set aside the same amount of funds each year for five years, starting immediately and earning a rate of 10% interest per year compound. To the nearest $100, how much does he need to set aside each year?

135. A company has four independent projects available:

If the company has $32,000 to invest at time 0, and each project is infinitely divisible, but none can be delayed, what is the maximum NPV that can be earned?

136. A project has an initial outflow at time 0 when an asset is bought, then a series of revenue inflows at the end of each year, and then finally sales proceeds from the sale of the asset. Its NPV is £12,000 when general inflation is zero % per year. If general inflation were to rise to 7% per year, and all revenue inflows were subject to this rate of inflation but the initial expenditure and resale value of the asset were not subject to inflation, what would happen to the NPV?

137. Which of the following statements in relation to a simulation exercise is correct?

138. A company receives a perpetuity of $20,000 per year in arrears, and pays 30% corporation tax 12 months after the end of the year to which the cash flows relate. At a cost of capital of 10%, what is the after-tax present value of the perpetuity?

139. Wasp Co needs to have $100,000 working capital in place immediately for the start of a 2 year project. The amount will stay constant in real terms. Inflation is running at 10% per year, and Wasp Co’s money cost of capital is 12%. What is the present value of the cash flows relating to working capital?

140. NW Co is considering investing $10,000 immediately in a 1-year project with the following cash flows. Income $100,000 Expenses $35,000 The cash flows will arise at the end of the year. The above are stated in current terms. Income is subject to 10% inflation; expenses will not vary.

The real cost of capital is 8% and general inflation is 2%. Using the money cost of capital to the nearest whole percentage, what is the NET present value of the project?

141. Indicate whether the following statements are true or false when considering standard deviation as a statistical measure.

A. The wider the dispersion, the less risky the situation

B. Standard deviation is the weighted average of all the possible outcomes

C. The tighter the distribution, the higher the standard deviation will be

D. Standard deviation is a measure of the variability of a distribution around its mean

142. Juicy Co is considering investing in a new industrial juicer for use on a new contract. It will cost $150,000 and will last 2 years. Juicy Co pays corporation tax at 30% (as the cash flows occur) and, due to the health benefits of juicing, the machine attracts 100% taxallowable depreciation immediately. Given a cost of capital of 10%, what is the minimum value of the pre-tax contract revenue receivable in two years which would be required to recover the net cost of the juicer?

143. An investment project has a cost of $12,000, payable at the start of the first year of operation. The possible future cash flows arising from the investment project have the following present values and associated probabilities:

What is the expected value of the net present value of the investment project (to the nearest $100)?

144. A lease versus buy evaluation has been performed. The management accountant performed the calculation by taking the saved initial outlay and deducting the taxadjusted lease payments and the lost capital allowances. The accountant discounted the net cash flows at the post-tax cost of borrowing. The resultant net present value (NPV) was positive. Assuming the calculation is free from arithmetical errors, what would the conclusion for this decision be?

145. A factory is attempting to choose between gas and electricity for its main heat source. Once a choice is made, the factory intends to keep to that source indefinitely. Each gas heating system has an NPV of $50,000 over its useful life of 5 years. Each electric heating system has an NPV of $68,000 over its useful life of 7 years. The cost of capital is 8%. Which should the factory choose and why?

The following information relates to questions 141 and 142.

Mishra Co is faced with an immediate capital constraint of $100m available to invest. It is considering investing in four divisible projects:

146. What is the NPV generated from the optimum investment programme?

147. What is the NPV generated from the optimum investment programme if the projects were indivisible?

148.Indicate which of the following are typically benefits of a shorter replacement cycle?