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MA – Nov 2024 – L2 – Q4a – Cost-Benefit Analysis (CBA) for Public Sector Investment

Evaluation of a healthcare capital investment project using cost-benefit analysis.

Question

The Faith Specialist Hospital (FSH) is a special government health facility under the Ghana Health Service (GHS) that provides specialized medical scans for complex health conditions. Management of FSH is planning to install an ultra-modern imaging machine that will improve the quality and accuracy of scans. The new installation will require an additional capital investment of GH¢420,000. The GHS policy on capital projects is that all new projects should achieve an internal rate of return of at least 30%.

Forecast demand for the services of this new machine over its five-year useful life are as follows:

Year	Number of Scans
1	1,250
2	2,700
3	3,500
4	1,400
5	675

Projected charge per scan: GH¢650
Variable costs per scan:

Consumables: GH¢330
Labour and overheads: GH¢176

Operating fixed costs per year: GH¢264,000 (includes depreciation on a straight-line basis)

Apart from the financial forecasts above, it is also envisaged that the project will produce non-financial benefits in several forms. Although it is hard to place a precise value on this, expert opinion suggests that this could approximate GH¢70,000 per annum.

Required:

i) Using cost-benefit analysis (CBA) computations, evaluate if the project should be undertaken.

ii) Enumerate TWO limitations of evaluating projects in the public sector.

Answer

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Tags: Capital Budgeting, Cost-benefit analysis, Investment Appraisal, IRR, Public Sector
Level: Level 2

Topic: Introduction to capital budgeting
Series: Nov 2024

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

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

Question

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?

Answer

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Tags: Cost of Capital, Decision Making, Investment Appraisal, IRR
Level: Level 1

Topic: Investment Decisions
Series: MAY 2023

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.

Question

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)

Answer

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Tags: Capital Rationing, Discounted Cash Flow, IRR, NPV
Level: Level 2

Topic: Capital rationing, Discounted cash flow
Series: MAY 2016

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

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

Question

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)

Answer

Find Related Questions by Tags, levels, etc.

Tags: IRR, NPV, Project Selection, Sensitivity Analysis
Level: Level 2

Topic: Capital rationing, Discounted cash flow
Series: NOV 2019

MA – Nov 2024 – L2 – Q4a – Cost-Benefit Analysis (CBA) for Public Sector Investment

Evaluation of a healthcare capital investment project using cost-benefit analysis.

Question

Forecast demand for the services of this new machine over its five-year useful life are as follows:

Year	Number of Scans
1	1,250
2	2,700
3	3,500
4	1,400
5	675

Projected charge per scan: GH¢650
Variable costs per scan:

Consumables: GH¢330
Labour and overheads: GH¢176

Operating fixed costs per year: GH¢264,000 (includes depreciation on a straight-line basis)

Required:

i) Using cost-benefit analysis (CBA) computations, evaluate if the project should be undertaken.

ii) Enumerate TWO limitations of evaluating projects in the public sector.

Answer

Find Related Questions by Tags, levels, etc.

Tags: Capital Budgeting, Cost-benefit analysis, Investment Appraisal, IRR, Public Sector
Level: Level 2

Topic: Introduction to capital budgeting
Series: Nov 2024

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

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

Question

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?

Answer

Find Related Questions by Tags, levels, etc.

Tags: Cost of Capital, Decision Making, Investment Appraisal, IRR
Level: Level 1

Topic: Investment Decisions
Series: MAY 2023

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.

Question

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)

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

Answer

Find Related Questions by Tags, levels, etc.

Tags: Capital Rationing, Discounted Cash Flow, IRR, NPV
Level: Level 2

Topic: Capital rationing, Discounted cash flow
Series: MAY 2016

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

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

Question

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%

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)

Answer

Find Related Questions by Tags, levels, etc.

Tags: IRR, NPV, Project Selection, Sensitivity Analysis
Level: Level 2

Topic: Capital rationing, Discounted cash flow
Series: NOV 2019

Question Tag: IRR

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MA – Nov 2024 – L2 – Q4a – Cost-Benefit Analysis (CBA) for Public Sector Investment

Evaluation of a healthcare capital investment project using cost-benefit analysis.

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

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

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.

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

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

MA – Nov 2024 – L2 – Q4a – Cost-Benefit Analysis (CBA) for Public Sector Investment

Evaluation of a healthcare capital investment project using cost-benefit analysis.

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

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

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.

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

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

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MA – Nov 2024 – L2 – Q4a – Cost-Benefit Analysis (CBA) for Public Sector Investment

Evaluation of a healthcare capital investment project using cost-benefit analysis.

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

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

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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.

You're reporting an error for "FM – MAY 2016 – L2 – Q1 – Capital rationing | Discounted cash flow"

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

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

You're reporting an error for "FM – Nov 2019 – L2 – Q4 – Capital rationing | Discounted cash flow"

MA – Nov 2024 – L2 – Q4a – Cost-Benefit Analysis (CBA) for Public Sector Investment

Evaluation of a healthcare capital investment project using cost-benefit analysis.

You're reporting an error for "MA – Nov 2024 – L2 – Q4a – Cost-Benefit Analysis (CBA) for Public Sector Investment"

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

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

You're reporting an error for "BMF – May 2023 – L1 – SB – Q2 – Investment Decisions"

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.

You're reporting an error for "FM – MAY 2016 – L2 – Q1 – Capital rationing | Discounted cash flow"

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

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

You're reporting an error for "FM – Nov 2019 – L2 – Q4 – Capital rationing | Discounted cash flow"

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