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  • 1.  Capital Budgeting Questions

    Posted 07-25-2013 12:27 PM
    This message has been cross posted to the following Discussions: CMA Study Group and Answer Exchange P2P Support .
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    Hi Guys

    I would appreciate to have the solutions for below questions and reasons as well. 

    Thanks



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    Muzahir Agha

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  • 2.  RE:Capital Budgeting Questions

    Posted 07-27-2013 01:08 AM

    Q214

    The correct answer here is letter B, $283,380.

    A project's NPV is the present value of the project's future expected cash flows minus the project's initial cash investment.

    To calculate the expected future cash flows, we consider the net cash income generated from the project, plus the depreciation tax shield, both discounted at the company's hurdle rate of 12%.

    Applying the probability percentages the expected annual unit sales is 92,000 (multiplying each annual unit sales by its probability of occurrence, and getting its sum).  

    Expected future cash flow  for 5 years   PV - 5yrs
    Net cash income after tax (92,000 units X $5 X 60%)         276,000 3.605          994,980
    Depreciation tax shield (1,000,000/5 yrs X 40% tax rate)           80,000 3.605          288,400
    Present value of all future cash flows on this project      1,283,380
    Present value of net cash investment      1,000,000
    Expected Net Present Value          283,380


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    Angel Secerio CMA, CPA
    Director/Manager
    Insights Financial Review Services Inc
    Makati City
    Philippines
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    Original Message


  • 3.  RE:Capital Budgeting Questions

    Posted 07-27-2013 02:21 AM

    Q 221

    Both projects should be accepted because both yield positive NPVs; so letter D is the correct answer.

    The riskier project will be applied a hurdle rate of 16%, while the less risky project needs to meet at least a 12% return to be acceptable.

    To determine which is riskier of the two, find out what the range of the deviation of the project cash flow is in relation to its expected cash inflow. Whichever yields the higher ratio means it is the riskier project.

    Project R:
    Expected cash flow is $95,000 [(.10 X 75,000) + (.80 X 95,000) + (.10 X 115,000]
    Deviation of highest to lowest cash flow is $40,000 (115,000 - 75,000)
    Ratio is 42% (40,000/95,000)

    Project S:
    Expected cash flow is $110,000 [(.25 X 70,000) + (.50 X 110,000) + (.25 X 150,000]
    Deviation of highest to lowest cash flow is $80,000 (150,000 - 70,000)
    Ratio is 73% (80,000/110,000) - PROJECT S IS RISKIER (APPLY 16%)

    NOTE: The expected cash flows on both projects just happen to be equal to its midpoint cash flow of $95,000 (@80% for Project R) and $110,000 (50% for Project S).

    Expected future cash flow  for 10 years 12% rate
    Present value of all future cash flows on this project        95,000 5.65        536,750
    Present value of net cash investment        500,000
    Expected Net Present Value (PROJECT R)         36,750
    Expected future cash flow  for 10 years 16% rate
    Present value of all future cash flows on this project      110,000 4.833        531,630
    Present value of net cash investment        500,000
    Expected Net Present Value (PROJECT S)         31,630


    -------------------------------------------
    Angel Secerio CMA, CPA
    Director/Manager
    Insights Financial Review Services Inc
    Makati City
    Philippines
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    Original Message


  • 4.  RE:Capital Budgeting Questions

    Posted 07-27-2013 03:41 AM

    Q 222

    Cash flow-wise, it is more feasible for the company to continue operating even at a loss than decide to discontinue its operation now. Note that the problem asked us to ignore tax impact in our analysis.

    Cash flow components if Logan continues to operate
    $ 3,750,000 - Net Cash contribution margin [150,000 X ($100 - $75)]
    $ 4,000,000 - Avoidable fixed costs
    $   250,000  - Net Cash Loss each year
    X    3.6000  - Present Value factor for 5 years at 12%

    $  900,000  - Net cash outflow if company continues to operate

    Cash flow components if Logan discontinues its operation
    $ 1,500,000 - Cash out for early cancellation of labor contract
    $    500,000 - Cash out for termination of supply contract
    $  (750,000) - Salvage value of production facility
    $ 1,250,000 - Net Cash out at Year 0

    NOTE: No present value factor should be applied for the second option as it happens in Year 0.

    $1,250,000
    $   900,000
    $   350,000 - NPV of benefit if Logan chooses to continue to operate  


    -------------------------------------------
    Angel Secerio CMA, CPA
    Director/Manager
    Insights Financial Review Services Inc
    Makati City
    Philippines
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    Original Message


  • 5.  RE:Capital Budgeting Questions

    Posted 07-27-2013 01:22 PM
    Once again many Thanks Angel for your prompt replies. I well understood these questions. 

    Regards

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    Muzahir Agha
    Dubai
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    Original Message