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Tuesday, May 7, 2013

MGT201 Assignment no 1 Solution 06-05-2013



MGT201 
Assignment no 1 


PROBLEM:


SNT Company is considering purchase of a new plant and machinery to supplement its manufacturing process. It has been anticipated that the new plant and machinery will involve an immediate cash investment of Rs. 500,000 and Rs. 800,000 in year 1. The after-tax cash inflows will be Rs. 150,000, Rs. 200,000 and Rs. 250,000 for year 2, 3 and 4 respectively. Afterwards, there will be a cash inflow of Rs. 300,000 each year from year 5 to year 10. Though the plant might be viable after 10 years but the company prefers to be conservative and end all calculations at that time. The company’s required rate of return is 14 percent. Considering yourself as financial analyst of the company, you are required to make the following calculations along with interpretations:
a)  What is the project’s payback period? Comment on the feasibility of project by considering

that firm’s required payback period is 5 years.   (3+1 Marks)

b)  What is the net present value of the project? Is it acceptable?           (5+1 Marks)

c)  What is the internal rate of return for the project? Is it acceptable? Support your decision with conceptual rationale            (8+2 Marks) NOTE: You are required to use the Interpolation Formula or Technique for calculating IRR; consult the relevant power point slideshow uploaded in the lesson contents of Lesson # 9. The slideshow can be accessed by using the following path:


Sign in to VULMS   Course Website   Lessons   Lesson 9   Resource Material

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SOLUTION IDEA


a)            Calculation of payback period.
Year
Cash flows
Commutative cash flows
0
-50000

1
-800000

2
150000
1500000
3
200000
350000
4
250000
600000
5
300000
900000
6
300000
1200000
7
300000
1500000
8
300000
1800000
9
300000
2100000
10
30000
2400000

                          
Payback period= 6 + 100000/300000
                         = 6.33 years
This project is not feasible because its payback period is greater than firm’s required payback period.


b) Calculation of NET PRESENT VALUE

Year
Cash flow
Cum cash flow
PV @14%
Present value
0
(500000)

1.00
(500000)
1
(800000)

0.877
(701600)
2
150000
150000
0.769
115350
3
200000
350000
0.675
135000
4
250000
600000
0.592
148000
5-10
300000
240000
2.304
691200
                                                                                        Net present value (-112050)

NPV is negative so project is not acceptable

C ) What is the internal rate of return for the project? Is it acceptable? Support your decision with conceptual rationale

Years
Cash flows
PV @ 11% discount
PV @ 10% discount
0
-500000


1
-800000


2
150000
121743.37
123966.94
3
200000
146238.27
150262.96
4
250000
164682.74
170753.36
5
300000
178035.39
186276.39
6
300000
160392.25
169342.17
7
300000
144497.52
153947.43
8
300000
130177.94
139952.2
9
300000
117277.43
127992.28
10
300000
105655.34
115662.986


 NPV @ 11% discount = -31299.75
 NPV @ 10% discount = 37393.7
IRR= Lower discount rate+ Difference of discount rates (NPV at lower discount rate/NPV at lower discount rates- NPV at higher discount rate
IRR= 11+1(37393.7/37397.3+31299.75)
IRR=11+ (0.5443)
IRR=11.54%

Because the internal rate of return is less than the required rate of return the project would not be acceptable.


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