Question Tag: Capital Investment

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  • 30 Marks

FM – Nov 2020 – L3 – Q1 – International Financial Management

Evaluates a foreign investment project in Linder, with NPV, payback period, and real options for abandonment analyzed under two scenarios.

Assume today is November 20, 2019. In 2018, the Oyin Division of Aba plc successfully launched a new premium wine, “Aladun,” in Nigeria. The Divisional Board of Oyin Division is now considering plans put forward by the Divisional Marketing Manager to launch the full range of Aladun in another country, “Linder.” Linder has the Linderian dollar (L$) as its currency, and the launch is planned for January 1, 2020.

It is known that breaking into the Linderian market for fruit wine is challenging due to strong local brand loyalty. Initial market research based on free tasting sessions has been promising, though uncertainties remain. The biggest risk identified is the potential for a Nigerian competitor to enter the same market with a similar product.

Financial Data for the Project:

  • Initial market research for the Linderian market: N5 million (already spent).
  • Additional detailed market research and packaging design (if approved): N20 million.
  • Launch campaign (radio and TV advertising): N10 million.
  • Distribution center in Linder: L$84 million.

Operating cash flow forecasts for the year ending December 31, 2020, vary based on two scenarios:

  • Scenario A: Sales revenue L$100 million; costs L$10 million + N20 million.
  • Scenario B: Sales revenue L$55 million; costs L$10 million + N15 million.
  • Probability of occurrence: 70% for Scenario A, 30% for Scenario B.

Other relevant financial data:

  • Oyin Division’s project evaluation discount rate: 15%.
  • Project duration: 4 years.
  • Expected operating cash flow growth: 5% per year.
  • Residual value of the distribution center: L$52 million after 4 years.
  • Exchange rate: N1 = L$1.2000 on January 1, 2020 (strengthening by 2% per year).
  • Corporate tax rate in Nigeria: 35%.
  • Tax allowances on capital expenditure: 100% (tax-deductible in Nigeria).

Additional Option:

  • The project could be abandoned on January 1, 2021, with the distribution center sold for an estimated L$70 million if Scenario B occurs.

Required:

a. Ignoring the abandonment option: i. Calculate the NPV for the project as of January 1, 2020, for each scenario and the overall total expected NPV. (17 Marks) ii. Calculate the payback period for each scenario. (4 Marks) iii. Interpret your results. (4 Marks)

b. Evaluate the abandonment decision on January 1, 2021, if Scenario B occurs. (7 Marks)

c. Advise on how real options and other strategic financial issues may influence the investment decision. (8 Marks)

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  • 15 Marks

FM – Nov 2017 – L3 – Q6 – Ethical Issues in Financial Management

Explore ethical considerations in capital investment and apply the Black-Scholes model in company valuation.

You have recently taken up employment with Large Plc., a Nigerian company with manufacturing subsidiaries in many countries across Africa. As the Financial Analyst, you report directly to the Managing Director who currently requires briefings on the following areas:

(i) Ethical issues and capital investment decisions,
(ii) Options and company valuation

Required:

a. Explain, with examples, ethical issues that might affect capital investment decisions and discuss the importance of such issues for Strategic Financial Management. (8 Marks)

b. Explain the circumstances in which the Black-Scholes Option Pricing (BSOP) model could be used to assess the value of a company, including the data required for the variables used in the model. (7 Marks)

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  • 15 Marks

PSAF – Nov 2021 – L2 – Q7 – Government Accounting Concepts and Principles

Calculate NPV for projects, profitability index, and discuss ranking differences.

Otunba Local Government wishes to boost its revenue generation and six possible capital investments have been identified. However, the Local Government only has access to a total of N6,200,000. The projects may not be postponed until a future period, and it is unlikely that similar investment opportunities will occur.

Expected net cash flows are:

Projects A and E are mutually exclusive while all the projects are believed to be of similar risk to the Local Government’s existing capital investments. Any surplus funds may be invested in the money market to earn a return of 9% per year. The money market may be assumed to be an efficient market. The Local Government’s cost of capital is 12% per year.

Required:

(a) Calculate the expected net present value for each project, and rank the projects. (8 Marks)
(b) Assuming the projects are divisible, calculate the Profitability Index for each project and rank the projects to determine how the money would be best invested. (6 Marks)
(c) State why the rankings in (b) differ from that in (a) above. (1 Mark)

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  • 20 Marks

BMF – May 2015 – L1 – SB – Q4 – Basics of Business Finance and Financial Markets

Discuss major cash flow items in capital investment projects and explain the payback period investment appraisal method.

a. List and explain FOUR major cashflow items to be included in a capital investment project. (8 Marks)
b.
i. Explain the payback period technique of investment appraisal. (4 Marks)
ii. State TWO advantages and TWO disadvantages of payback period. (8 Marks)

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  • 1 Marks

BMF – May 2022 – L1 – SA – Q12 – Basics of Business Finance and Financial Markets

Calculating the return on average investment for a machine.

The return on average investment is
A. 15.78%
B. 16.78%
C. 17.78%
D. 18.78%
E. 19.78%

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  • 1 Marks

BMF – May 2022 – L1 – SA – Q11 – Basics of Business Finance and Financial Markets

Calculating the return on the original investment of a machine.

The return on (original) investment is
A. 10%
B. 15%
C. 20%
D. 25%
E. 30%

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  • 10 Marks

AFM – May 2019 – L3 – Q2a – Discounted cash flow techniques

Compare leasing and buying options for a machine and recommend the most viable choice based on net present value analysis.

Rahim Ltd requires a machine for 5 years. There are two alternatives, either to take it on lease or buy basis. The company is reluctant to invest an initial amount for the project and approaches their bankers. The bankers are ready to finance 100% of its initial required amount at a 15% rate of interest for any of the alternatives.

Under lease option, an upfront security deposit of GH¢5,000,000 is payable to the lessor, which is equal to the cost of the machine. Out of which, 40% shall be adjusted equally against annual lease rent. At the end of life of the machine, the expected scrap value will be at book value after providing depreciation at 20% on written down value basis.

Under the buying option, loan repayment is in equal annual installments of the principal amount, which is equal to annual lease rent charges. However, in the case of bank finance for the lease option, repayment of principal amount equal to lease rent is adjusted every year, and the balance at the end of 5th year.

Assume income tax rate is 30%, interest is payable at the end of every year, and discount rate at 15% p.a. The following discounting factors are given:

Year Factor
1 0.8696
2 0.7562
3 0.6576
4 0.5718
5 0.4972

Required:
Recommend the most viable option on the basis of net present values.

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  • 10 Marks

MA – May 2020 – L2 – Q4a – Introduction to capital budgeting, Decision making techniques

Identify and explain the stages in the capital investment decision-making process.

a) Senchi Ltd is evaluating an investment proposal to manufacture River boat, which has performed well in test marketing trials conducted recently by the company’s research and development division.

Required:

Identify and explain the stages in the capital investment decision-making process. (10 marks)

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  • 5 Marks

MA – Nov 2018 – L2 – Q1b – Divisional Performance

Evaluate the impact of scrapping an inefficient bus on the ROI of a transportation business unit.

Super Express Transport Company runs a fleet of buses on the Accra-Sunyani route, which is considered a business unit.

The following is an extract from the final accounts of the company as at the last operating year:

  • Stock of buses on that route at cost less depreciation is GH¢660,000.
  • Net operating profit is GH¢198,000.

One of the buses, bought three years ago at the cost of GH¢150,000, was not performing efficiently because it got involved in an accident just a year after it was purchased. Although the damage was minor, the Operations Manager suggested that the bus be scrapped, in spite of the fact that it earned a profit of GH¢6,000 in the year. Depreciation is at the rate of 20% p.a. on a straight-line basis.

Required:
Evaluate the effect of this proposal on the performance of the business unit, if Return on Investment (ROI) is used to measure the performance of subunits. (5 marks)

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  • 20 Marks

FM – March 2023 – L2 – Q4 – DCF: taxation and inflation | Introduction to Investment Appraisal

Explain the stages in the capital investment decision-making process, compute the discounted payback period and Return on Capital Employed for an investment proposal, and describe categories of financial markets with examples.

a) Explain the stages in the Capital Investment decision-making process. (5 marks)

b) Dragon Ltd is evaluating an investment proposal to manufacture a product called “Chiputronic” and the information below has been provided by the Research and Development team:

  • Initial Investment: GH¢4 million
  • Selling Price (current price terms): GH¢40 per unit
  • Expected Selling Price Inflation: 3% per annum
  • Variable Operating Cost (current price terms): GH¢16 per unit
  • Fixed Operating Cost (current price terms): GH¢340,000
  • Expected Operating Cost Inflation: 4% per annum
Year Annual Demand (units)
1 70,000
2 90,000
3 130,000
4 50,000

It is expected that whatever is produced will be sold with no stock left, and there will be no scrap value expected at the end of the four years. The discount rate used in the company is 15%.

Required:
i) Compute the discounted payback period. (5 marks)
ii) Calculate the Return on Capital Employed (Accounting Rate of Return) based on average investment. (5 marks)

c) Financial markets facilitate the interaction between those who need funds and those who have funds to invest.

Required:
Explain TWO (2) categories of financial markets and give TWO (2) examples of each. (5 marks)

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  • 30 Marks

FM – Nov 2020 – L3 – Q1 – International Financial Management

Evaluates a foreign investment project in Linder, with NPV, payback period, and real options for abandonment analyzed under two scenarios.

Assume today is November 20, 2019. In 2018, the Oyin Division of Aba plc successfully launched a new premium wine, “Aladun,” in Nigeria. The Divisional Board of Oyin Division is now considering plans put forward by the Divisional Marketing Manager to launch the full range of Aladun in another country, “Linder.” Linder has the Linderian dollar (L$) as its currency, and the launch is planned for January 1, 2020.

It is known that breaking into the Linderian market for fruit wine is challenging due to strong local brand loyalty. Initial market research based on free tasting sessions has been promising, though uncertainties remain. The biggest risk identified is the potential for a Nigerian competitor to enter the same market with a similar product.

Financial Data for the Project:

  • Initial market research for the Linderian market: N5 million (already spent).
  • Additional detailed market research and packaging design (if approved): N20 million.
  • Launch campaign (radio and TV advertising): N10 million.
  • Distribution center in Linder: L$84 million.

Operating cash flow forecasts for the year ending December 31, 2020, vary based on two scenarios:

  • Scenario A: Sales revenue L$100 million; costs L$10 million + N20 million.
  • Scenario B: Sales revenue L$55 million; costs L$10 million + N15 million.
  • Probability of occurrence: 70% for Scenario A, 30% for Scenario B.

Other relevant financial data:

  • Oyin Division’s project evaluation discount rate: 15%.
  • Project duration: 4 years.
  • Expected operating cash flow growth: 5% per year.
  • Residual value of the distribution center: L$52 million after 4 years.
  • Exchange rate: N1 = L$1.2000 on January 1, 2020 (strengthening by 2% per year).
  • Corporate tax rate in Nigeria: 35%.
  • Tax allowances on capital expenditure: 100% (tax-deductible in Nigeria).

Additional Option:

  • The project could be abandoned on January 1, 2021, with the distribution center sold for an estimated L$70 million if Scenario B occurs.

Required:

a. Ignoring the abandonment option: i. Calculate the NPV for the project as of January 1, 2020, for each scenario and the overall total expected NPV. (17 Marks) ii. Calculate the payback period for each scenario. (4 Marks) iii. Interpret your results. (4 Marks)

b. Evaluate the abandonment decision on January 1, 2021, if Scenario B occurs. (7 Marks)

c. Advise on how real options and other strategic financial issues may influence the investment decision. (8 Marks)

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  • 15 Marks

FM – Nov 2017 – L3 – Q6 – Ethical Issues in Financial Management

Explore ethical considerations in capital investment and apply the Black-Scholes model in company valuation.

You have recently taken up employment with Large Plc., a Nigerian company with manufacturing subsidiaries in many countries across Africa. As the Financial Analyst, you report directly to the Managing Director who currently requires briefings on the following areas:

(i) Ethical issues and capital investment decisions,
(ii) Options and company valuation

Required:

a. Explain, with examples, ethical issues that might affect capital investment decisions and discuss the importance of such issues for Strategic Financial Management. (8 Marks)

b. Explain the circumstances in which the Black-Scholes Option Pricing (BSOP) model could be used to assess the value of a company, including the data required for the variables used in the model. (7 Marks)

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  • 15 Marks

PSAF – Nov 2021 – L2 – Q7 – Government Accounting Concepts and Principles

Calculate NPV for projects, profitability index, and discuss ranking differences.

Otunba Local Government wishes to boost its revenue generation and six possible capital investments have been identified. However, the Local Government only has access to a total of N6,200,000. The projects may not be postponed until a future period, and it is unlikely that similar investment opportunities will occur.

Expected net cash flows are:

Projects A and E are mutually exclusive while all the projects are believed to be of similar risk to the Local Government’s existing capital investments. Any surplus funds may be invested in the money market to earn a return of 9% per year. The money market may be assumed to be an efficient market. The Local Government’s cost of capital is 12% per year.

Required:

(a) Calculate the expected net present value for each project, and rank the projects. (8 Marks)
(b) Assuming the projects are divisible, calculate the Profitability Index for each project and rank the projects to determine how the money would be best invested. (6 Marks)
(c) State why the rankings in (b) differ from that in (a) above. (1 Mark)

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  • 20 Marks

BMF – May 2015 – L1 – SB – Q4 – Basics of Business Finance and Financial Markets

Discuss major cash flow items in capital investment projects and explain the payback period investment appraisal method.

a. List and explain FOUR major cashflow items to be included in a capital investment project. (8 Marks)
b.
i. Explain the payback period technique of investment appraisal. (4 Marks)
ii. State TWO advantages and TWO disadvantages of payback period. (8 Marks)

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  • 1 Marks

BMF – May 2022 – L1 – SA – Q12 – Basics of Business Finance and Financial Markets

Calculating the return on average investment for a machine.

The return on average investment is
A. 15.78%
B. 16.78%
C. 17.78%
D. 18.78%
E. 19.78%

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  • 1 Marks

BMF – May 2022 – L1 – SA – Q11 – Basics of Business Finance and Financial Markets

Calculating the return on the original investment of a machine.

The return on (original) investment is
A. 10%
B. 15%
C. 20%
D. 25%
E. 30%

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  • 10 Marks

AFM – May 2019 – L3 – Q2a – Discounted cash flow techniques

Compare leasing and buying options for a machine and recommend the most viable choice based on net present value analysis.

Rahim Ltd requires a machine for 5 years. There are two alternatives, either to take it on lease or buy basis. The company is reluctant to invest an initial amount for the project and approaches their bankers. The bankers are ready to finance 100% of its initial required amount at a 15% rate of interest for any of the alternatives.

Under lease option, an upfront security deposit of GH¢5,000,000 is payable to the lessor, which is equal to the cost of the machine. Out of which, 40% shall be adjusted equally against annual lease rent. At the end of life of the machine, the expected scrap value will be at book value after providing depreciation at 20% on written down value basis.

Under the buying option, loan repayment is in equal annual installments of the principal amount, which is equal to annual lease rent charges. However, in the case of bank finance for the lease option, repayment of principal amount equal to lease rent is adjusted every year, and the balance at the end of 5th year.

Assume income tax rate is 30%, interest is payable at the end of every year, and discount rate at 15% p.a. The following discounting factors are given:

Year Factor
1 0.8696
2 0.7562
3 0.6576
4 0.5718
5 0.4972

Required:
Recommend the most viable option on the basis of net present values.

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  • 10 Marks

MA – May 2020 – L2 – Q4a – Introduction to capital budgeting, Decision making techniques

Identify and explain the stages in the capital investment decision-making process.

a) Senchi Ltd is evaluating an investment proposal to manufacture River boat, which has performed well in test marketing trials conducted recently by the company’s research and development division.

Required:

Identify and explain the stages in the capital investment decision-making process. (10 marks)

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  • 5 Marks

MA – Nov 2018 – L2 – Q1b – Divisional Performance

Evaluate the impact of scrapping an inefficient bus on the ROI of a transportation business unit.

Super Express Transport Company runs a fleet of buses on the Accra-Sunyani route, which is considered a business unit.

The following is an extract from the final accounts of the company as at the last operating year:

  • Stock of buses on that route at cost less depreciation is GH¢660,000.
  • Net operating profit is GH¢198,000.

One of the buses, bought three years ago at the cost of GH¢150,000, was not performing efficiently because it got involved in an accident just a year after it was purchased. Although the damage was minor, the Operations Manager suggested that the bus be scrapped, in spite of the fact that it earned a profit of GH¢6,000 in the year. Depreciation is at the rate of 20% p.a. on a straight-line basis.

Required:
Evaluate the effect of this proposal on the performance of the business unit, if Return on Investment (ROI) is used to measure the performance of subunits. (5 marks)

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  • 20 Marks

FM – March 2023 – L2 – Q4 – DCF: taxation and inflation | Introduction to Investment Appraisal

Explain the stages in the capital investment decision-making process, compute the discounted payback period and Return on Capital Employed for an investment proposal, and describe categories of financial markets with examples.

a) Explain the stages in the Capital Investment decision-making process. (5 marks)

b) Dragon Ltd is evaluating an investment proposal to manufacture a product called “Chiputronic” and the information below has been provided by the Research and Development team:

  • Initial Investment: GH¢4 million
  • Selling Price (current price terms): GH¢40 per unit
  • Expected Selling Price Inflation: 3% per annum
  • Variable Operating Cost (current price terms): GH¢16 per unit
  • Fixed Operating Cost (current price terms): GH¢340,000
  • Expected Operating Cost Inflation: 4% per annum
Year Annual Demand (units)
1 70,000
2 90,000
3 130,000
4 50,000

It is expected that whatever is produced will be sold with no stock left, and there will be no scrap value expected at the end of the four years. The discount rate used in the company is 15%.

Required:
i) Compute the discounted payback period. (5 marks)
ii) Calculate the Return on Capital Employed (Accounting Rate of Return) based on average investment. (5 marks)

c) Financial markets facilitate the interaction between those who need funds and those who have funds to invest.

Required:
Explain TWO (2) categories of financial markets and give TWO (2) examples of each. (5 marks)

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