Question Tag: IRR

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  • 20 Marks

BMF – May 2023 – L1 – SB – Q2 – Investment Decisions

Use the IRR method to evaluate two projects and recommend which one should be selected.

Johnson and Jacob Limited is considering whether to invest in one of these two projects. The expected cash flows are as stated below:

Year Project Blue (N’000) Project Pink (N’000)
0 (33,000) (30,000)
1 18,000 3,000
2 6,000 3,000
3 3,000 6,000
4 15,000 30,000

The company anticipates a cost of capital of 12%. Using the Internal Rate of Return (IRR) method of investment appraisal, which of the projects should be selected?

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  • 20 Marks

FM – MAY 2016 – L2 – Q1 – Capital rationing | Discounted cash flow

Appraise project PA205 using NPV criteria, sensitivity analysis, and capital rationing advice. Discuss ways to address capital constraints.

ABC Ltd is considering five projects for the coming financial year. Four of the projects have undergone financial appraisal (see the table below).

Project Lifespan Initial investment (GH¢) NPV (GH¢) IRR
PA201 Indefinite (50,000) 85,200 11.5%
PA202 Indefinite (75,000) 98,500 12.3%
PA203 Indefinite (48,000) 65,950 10.2%
PA204 Indefinite (85,000) 95,400 11.4%
PA205 Indefinite (150,000) Yet to be appraised Yet to be appraised

Project PA205 entails an immediate capital investment of GH¢150,000 and will produce the following annual net cash flows in real terms:

Year 1 2 3 4 5 Every year after year 5
Cash flow (GH¢) 5,000 10,500 25,000 28,000 30,000 30,000

Expected general rate of inflation is 15% and the company’s money required rate of return is 25%.

Required:

a) Appraise Project PA205 using the NPV criteria. (4 marks)
b) Assess the sensitivity of Project PA205 to the discount rate. (4 marks)

c) Suppose in the coming financial year, only GH¢200,000 of finance will be available for investments but the capital constraint will ease afterwards. Advise the company on which project(s) to implement in the coming year if the projects are –

i) Independent and divisible (3 marks)
ii) Independent and indivisible (3 marks)

d) When management rejects projects with positive net present value because of capital constraints, they lose opportunities to enhance the value of shareholders. Suggest three practical ways of dealing with capital rationing so as not to discard projects with positive net present value. (6 marks)

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  • 20 Marks

FM – Nov 2019 – L2 – Q4 – Capital rationing | Discounted cash flow

Compute NPV and IRR, assess sensitivity, and recommend a project portfolio under capital rationing.

The current financial year of General Kapito Ltd, a sports apparel company based in Ghana, will be ending in two months’ time. The directors of the company will be meeting next week to approve capital projects that will be implemented in the coming financial year. A major concern for the coming year is the availability of finance to meet investment requirements.

The cost of raising new capital in Ghana’s capital market has risen so high that it is not cost-effective to raise small blocks of capital. Consequently, the directors of the company have decided to finance new projects in the coming year with retained earnings and not raise new external capital from the capital market to bridge any financing gap. The maximum amount of retained earnings that will be available for financing new capital projects in the coming year is GH¢62 million.

There are six independent projects that will be presented before the board of directors for approval in their upcoming meeting. Five of the projects have been appraised already (see a summary of the projects in the table below).

Project Investment requirement Net present value (NPV) Internal rate of return (IRR)
PROJECT-01 25 50 36.2%
PROJECT-02 15 45 37.1%
PROJECT-03 9 35 39.5%
PROJECT-04 12 20 34.8%
PROJECT-05 34 To be computed To be computed
PROJECT-06 5 2 33.5%

Project-05 refers to a 5-year contract with a local football club for the manufacture and supply of a special football boot for playing under rainy conditions. It is estimated that this project will require an investment of GH¢34 million in plant and equipment at the start of the first year. The estimated cost of required plant and equipment might change as there are speculations about probable change in technology in the coming year. That notwithstanding, this project is expected to return an after-tax net operating cash flow of GH¢13.5 million every year over the coming five years. The estimated after-tax salvage value of the plant and equipment is GH¢10 million at the end of the fifth year.

The company’s required rate of return is 25%.

Required:

a) Compute the NPV and IRR of Project-05. (10 marks)

b) Assess the sensitivity of the outcome of Project-05 to variations in the cost of plant and equipment. Interpret your result. (5 marks)

c) Assuming the projects are divisible, recommend the portfolio of projects that should be funded in the coming year. (5 marks)

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  • 20 Marks

BMF – May 2023 – L1 – SB – Q2 – Investment Decisions

Use the IRR method to evaluate two projects and recommend which one should be selected.

Johnson and Jacob Limited is considering whether to invest in one of these two projects. The expected cash flows are as stated below:

Year Project Blue (N’000) Project Pink (N’000)
0 (33,000) (30,000)
1 18,000 3,000
2 6,000 3,000
3 3,000 6,000
4 15,000 30,000

The company anticipates a cost of capital of 12%. Using the Internal Rate of Return (IRR) method of investment appraisal, which of the projects should be selected?

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  • 20 Marks

FM – MAY 2016 – L2 – Q1 – Capital rationing | Discounted cash flow

Appraise project PA205 using NPV criteria, sensitivity analysis, and capital rationing advice. Discuss ways to address capital constraints.

ABC Ltd is considering five projects for the coming financial year. Four of the projects have undergone financial appraisal (see the table below).

Project Lifespan Initial investment (GH¢) NPV (GH¢) IRR
PA201 Indefinite (50,000) 85,200 11.5%
PA202 Indefinite (75,000) 98,500 12.3%
PA203 Indefinite (48,000) 65,950 10.2%
PA204 Indefinite (85,000) 95,400 11.4%
PA205 Indefinite (150,000) Yet to be appraised Yet to be appraised

Project PA205 entails an immediate capital investment of GH¢150,000 and will produce the following annual net cash flows in real terms:

Year 1 2 3 4 5 Every year after year 5
Cash flow (GH¢) 5,000 10,500 25,000 28,000 30,000 30,000

Expected general rate of inflation is 15% and the company’s money required rate of return is 25%.

Required:

a) Appraise Project PA205 using the NPV criteria. (4 marks)
b) Assess the sensitivity of Project PA205 to the discount rate. (4 marks)

c) Suppose in the coming financial year, only GH¢200,000 of finance will be available for investments but the capital constraint will ease afterwards. Advise the company on which project(s) to implement in the coming year if the projects are –

i) Independent and divisible (3 marks)
ii) Independent and indivisible (3 marks)

d) When management rejects projects with positive net present value because of capital constraints, they lose opportunities to enhance the value of shareholders. Suggest three practical ways of dealing with capital rationing so as not to discard projects with positive net present value. (6 marks)

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  • 20 Marks

FM – Nov 2019 – L2 – Q4 – Capital rationing | Discounted cash flow

Compute NPV and IRR, assess sensitivity, and recommend a project portfolio under capital rationing.

The current financial year of General Kapito Ltd, a sports apparel company based in Ghana, will be ending in two months’ time. The directors of the company will be meeting next week to approve capital projects that will be implemented in the coming financial year. A major concern for the coming year is the availability of finance to meet investment requirements.

The cost of raising new capital in Ghana’s capital market has risen so high that it is not cost-effective to raise small blocks of capital. Consequently, the directors of the company have decided to finance new projects in the coming year with retained earnings and not raise new external capital from the capital market to bridge any financing gap. The maximum amount of retained earnings that will be available for financing new capital projects in the coming year is GH¢62 million.

There are six independent projects that will be presented before the board of directors for approval in their upcoming meeting. Five of the projects have been appraised already (see a summary of the projects in the table below).

Project Investment requirement Net present value (NPV) Internal rate of return (IRR)
PROJECT-01 25 50 36.2%
PROJECT-02 15 45 37.1%
PROJECT-03 9 35 39.5%
PROJECT-04 12 20 34.8%
PROJECT-05 34 To be computed To be computed
PROJECT-06 5 2 33.5%

Project-05 refers to a 5-year contract with a local football club for the manufacture and supply of a special football boot for playing under rainy conditions. It is estimated that this project will require an investment of GH¢34 million in plant and equipment at the start of the first year. The estimated cost of required plant and equipment might change as there are speculations about probable change in technology in the coming year. That notwithstanding, this project is expected to return an after-tax net operating cash flow of GH¢13.5 million every year over the coming five years. The estimated after-tax salvage value of the plant and equipment is GH¢10 million at the end of the fifth year.

The company’s required rate of return is 25%.

Required:

a) Compute the NPV and IRR of Project-05. (10 marks)

b) Assess the sensitivity of the outcome of Project-05 to variations in the cost of plant and equipment. Interpret your result. (5 marks)

c) Assuming the projects are divisible, recommend the portfolio of projects that should be funded in the coming year. (5 marks)

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