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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