Topic: Discounted cash flow

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  • 15 Marks

MA – Mar 2023 – L2 – Q4a – Discounted cash flow

Determine whether Arkoo Ltd's project is viable using the NPV method.

Question:
Arkoo Ltd (Arkoo) is planning to invest GH¢5 million in its sound engineering studio with a life span of 10 years. Arkoo charges GH¢5.50 for every compact disc (CD) produced with an associated cost of GH¢4.80. The company plans to produce 8,700,000 CDs each year. Arkoo evaluates all investment opportunities against a discount factor of 21%.

Required:
i) Determine whether the project is viable or not using the Net Present Value (NPV) method.
ii) Calculate the percentage by which the following conditioning factors of Arkoo must change
in order for NPV to be zero.

  • Selling price (3 marks)

    • Variable cost (3 marks)

  • Sales Volume (3 marks)
  • Initial investment (3 marks)

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  • 15 Marks

MA – Nov 2019 – L2 – Q4a – Introduction to capital budgeting

Select the appropriate plant for Pagsana Company using Payback Period and NPV analysis.

a) Pagsana Company plans to introduce a new product line for production of its local drink in Walewale. The company, therefore, decided to acquire either a semi-automated plant or an automated plant. The relevant data for the two proposed plants are as follows:

Required:
i) Select the appropriate plant on the basis of:

  • Payback Period (4 marks)
  • Net Present Value

(7 marks)

ii) Explain TWO (2) advantages of discounted cashflow method of investment appraisal. (4 marks)

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  • 15 Marks

MA – Aug 2022 – L2 – Q4a – Discounted Cash Flow

This question involves calculating the IRR to assess the viability of acquiring a new plant for Tanko Ltd.

Tanko Ltd (TL) is engaged in the manufacturing and sale of a single product GG. The existing manufacturing plant is being operated at full capacity of 6,000 units per annum, but the production is not sufficient to meet the growing demand of GG. TL is considering replacing its existing plant with a new Japanese plant. The production capacity of the new plant would be 50% more than the existing capacity. The board of TL considers this expansion a high-risk investment and requires a minimum expected rate of return of 15% on its investment.

To assess the viability of this decision, the following information has been gathered:
i) The purchase cost and installation cost of the new plant will amount to GH¢3.14 million and GH¢0.45 million, respectively.
ii) The supplier would send a team of engineers to Ghana for final inspection of the plant before commissioning at a cost of GH¢120,000. 50% of this cost would be borne by TL.
iii) As a result of the installation of the new plant, fixed costs other than depreciation would increase by GH¢0.3 million per annum.
iv) The existing plant has an estimated life of 10 years and has been in use for the last 6 years. The machine supplier has offered to purchase the existing plant immediately at GH¢1.6 million.
v) During the latest year, 6,000 units were sold at an average selling price of GH¢550 per unit. Variable manufacturing cost was GH¢450 per unit. TL expects to increase sales volume by 25% in the first year after the plant’s installation. Thereafter, the sales volume would increase by 4% per annum. Selling price and variable manufacturing cost will increase by 5% per annum.
vi) The new plant would be depreciated using the straight-line method. The residual value of the plant at the end of its useful life of 4 years is estimated at GH¢350,000.
vii) TL’s cost of capital is 12%.

Required:
Using break-even rate (internal rate of return), advise whether TL should acquire the new plant.

 

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  • 5 Marks

MA – Mar 2024 – L2 – Q1b – Divisional performance | Discounted Cash Flow

This question explains why the divisional manager may reject an option with a higher NPV and discusses board acceptability.

The performance bonus of the fragrance divisional manager is linked to Return on Investment (ROI) and Residual Income (RI) and has an impact on the calculation of retirement benefits. The manager is due to retire at the beginning of Year 3.

Required:
Explain why the fragrance Divisional Manager will not invest in the option showing the higher NPV and comment on whether it will be acceptable to the Board

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  • 15 Marks

MA – Dec 2023 – L2 – Q4a – Discounted Cash Flow

This question involves calculating the NPV for three projects being considered by Kanfa Ltd and recommending the best project based on financial grounds.

Kanfa Ltd received GH¢50 million as compensation from Ghana Highways Authority (GHA) when one of its properties was destroyed to pave way for the Accra–Kumasi highway construction. Management of Kanfa Ltd has decided to invest the amount received in one of three capital investment opportunities identified.

Project A:

This is a long-term project, which would run for 20 years and will require an immediate outlay of GH¢50 million and net annual cash profits as follows:

  • 1st to 5th years: GH¢2 million
  • 6th to 10th years: GH¢8 million
  • 11th to 15th years: GH¢15 million
  • 16th to 20th years: GH¢5 million

At the end of the 20th year, the project would be decommissioned at a cost of GH¢2 million.

Project B:

Kanfa Ltd is considering opening a Tourist Attraction Centre in Cape Coast, with an initial capital investment of GH¢50 million. It will operate for five years and be sold at an estimated price of GH¢5 million. The market research survey estimates the following visitor numbers and probabilities:

  • 800,000 visitors (30%)
  • 600,000 visitors (50%)
  • 400,000 visitors (20%)

Entrance fee: GH¢40 per visitor, and each visitor is expected to spend GH¢15 on souvenirs and GH¢5 on refreshments. Variable costs per visitor: GH¢25 (including souvenirs and refreshments). Maintenance costs: GH¢2 million per annum.

Project C:

This project involves a current outlay of GH¢50 million on equipment and GH¢15 million on working capital immediately. The working capital will increase to GH¢21 million in year one. Net annual cash profits: GH¢18 million for six years. The capital equipment can be sold for GH¢5 million at the end of the project.

Other information:

  • The company’s cost of capital is 12% for the three projects.
  • Ignore taxation and inflation.

Required:
Calculate the Net Present Value (NPV) of each project and recommend which project the company should undertake on financial grounds.

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  • 10 Marks

MA – Nov 2017 – L2 – Q1a – Discounted cash flow

Calculate the net present value of a new software game investment project and provide commentary on the findings.

a) Agyasco Ltd, a software company has developed a new game “Lando” which it plans to launch in the near future. Sales volumes, production volumes and selling prices for “Lando” over its four-year life are expected to be as follows:

Financial information on “Lando” for the first year of production is as follows: Direct material cost GH¢5.4 per game Other variable production cost GH¢6.00 per game Fixed costs GH¢4.00 per game.

Advertising costs to simulate demand are expected to be GH¢650,000 in the first year of production and GH¢100,000 in the second year of production. No advertising costs are expected in the third and fourth years of production. Fixed costs represent incremental cash fixed production overheads. “Lando” will be produced on a new production machine costing GH¢800,000. Although this production machine is expected to have a useful life of up to 10 years, Government legislation allows Agyasco Ltd to claim the capital cost of the machine against the manufacture of a single product. Capital allowances will therefore be claimed on a straight-line basis over four years.

Agyasco Ltd pays tax on profit at a rate of 30% per annum and tax liabilities are settled in the year in which they arise. Agyasco Ltd uses an after-tax discount rate of 10% when appraising new capital investments. Ignore inflation.

Required: Calculate the net present value of the proposed investment and comment on your findings.

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  • 10 Marks

MA – May 2018 – L2 – Q1a – Discounted cash flow

Compare the NPV of maintaining old equipment versus buying new equipment to advise management on the better option.

The Maintenance Manager of Prudence Ltd insists that management should maintain an old equipment that had been used for 5 years and is fully depreciated rather than buy a new one. The old equipment has a current operating cost of GH¢53,000.00 per annum. The operating cost of the equipment is expected to increase at 5% every year over the next four years, with a sale value of GH¢6,500.00 in the fifth year.

The Maintenance Manager has proposed, that a new system with enhanced technology to reduce operating cost to GH¢32,000.00 for the next three years and GH¢33,600.00 for the fourth and fifth years be introduced. The new equipment will cost GH¢60,000.00 and when introduced, a redundancy cost of GH¢25,000.00 will be paid, with the old equipment sold for GH¢12,000.00. The sale value of the new equipment will be GH¢10,200.00 after its five years’ useful life.

Required:
Using Net Present Value (NPV) method of capital appraisal with 20% cost of capital, advise management on which option Prudence Ltd should go for.

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  • 15 Marks

MA – July 2023 – L2 – Q4a – Discounted cash flow

Calculate the cost of capital for a delivery van investment using IRR, and compare payback and discounted cash flow methods of investment appraisal.

a) Johnson & Co is a medium sized company that is engaged in delivery services. As a result
of the recent increase in the demand for services, the Managing Director (MD) is planning
for the future business performance. The MD plans to acquire a delivery van at the cost of
GH¢85,000. The expected net cash flow per year are as follows:

The Sales Manager has indicated to the MD that he will recoup his investment in less than four years and for that reason, it’s a good investment.

The Management Accountant has however drawn his attention to the fact that the manager has not factored time value of money and the cost of capital in his analysis. He could not however suggest the cost of capital since financial institutions are charging different interest rates.

Required:

i) Calculate the cost of capital when used would result in a break-even, when the useful life of the van is five years with residual value of GH¢8,500. (11 marks)

ii) Using TWO (2) points each, compare and contrast the payback method of investment appraisal and the discounted cash flow method.

(4 marks)

 

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  • 11 Marks

MA – Nov 2020 – L2 – Q4a – Discounted Cash Flow

Calculate the cost of capital to break-even for a van investment over five years and discuss the advantages and disadvantages of the payback method.

a) Jayjay & Co is a medium-sized company that is engaged in delivery services. As a result of the recent increase in the demand for its services, the Managing Director (MD) is planning to acquire a delivery van at the cost of GH¢85,000. The expected net cash flow per year is as follows:

Year Net Cash Flow (GH¢)
1 25,000
2 28,000
3 39,000
4 34,000
5 24,000

The Sales Manager has indicated to the MD that the company will recoup its investment in less than four years, and for that reason, it’s a good investment. The Management Accountant, however, has drawn the MD’s attention to the fact that the Sales Manager has not factored in the time value of money and the cost of capital into his analysis.

Required:

i) Calculate the cost of capital that, when used, will make the investment break-even when the useful life of the van is five years with a residual value of GH¢8,500.
ii) Explain TWO (2) advantages and TWO (2) disadvantages of the payback method of investment appraisal and show how it compares to the discounted cash flow method.

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  • 6 Marks

MA – May 2020 – L2 – Q4b – Discounted cash flow

Explain the elements that determine the time value of money and its importance in investment appraisal.

b) The main reason why discounted cash flow methods of investment appraisal are considered theoretically superior is that they take into account the time value of money.

Required:

Explain THREE (3) elements that determine the time value of money and why it is important to take them into consideration when appraising investment projects. (6 marks)

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  • 15 Marks

MA – Mar 2023 – L2 – Q4a – Discounted cash flow

Determine whether Arkoo Ltd's project is viable using the NPV method.

Question:
Arkoo Ltd (Arkoo) is planning to invest GH¢5 million in its sound engineering studio with a life span of 10 years. Arkoo charges GH¢5.50 for every compact disc (CD) produced with an associated cost of GH¢4.80. The company plans to produce 8,700,000 CDs each year. Arkoo evaluates all investment opportunities against a discount factor of 21%.

Required:
i) Determine whether the project is viable or not using the Net Present Value (NPV) method.
ii) Calculate the percentage by which the following conditioning factors of Arkoo must change
in order for NPV to be zero.

  • Selling price (3 marks)

    • Variable cost (3 marks)

  • Sales Volume (3 marks)
  • Initial investment (3 marks)

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  • 15 Marks

MA – Nov 2019 – L2 – Q4a – Introduction to capital budgeting

Select the appropriate plant for Pagsana Company using Payback Period and NPV analysis.

a) Pagsana Company plans to introduce a new product line for production of its local drink in Walewale. The company, therefore, decided to acquire either a semi-automated plant or an automated plant. The relevant data for the two proposed plants are as follows:

Required:
i) Select the appropriate plant on the basis of:

  • Payback Period (4 marks)
  • Net Present Value

(7 marks)

ii) Explain TWO (2) advantages of discounted cashflow method of investment appraisal. (4 marks)

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  • 15 Marks

MA – Aug 2022 – L2 – Q4a – Discounted Cash Flow

This question involves calculating the IRR to assess the viability of acquiring a new plant for Tanko Ltd.

Tanko Ltd (TL) is engaged in the manufacturing and sale of a single product GG. The existing manufacturing plant is being operated at full capacity of 6,000 units per annum, but the production is not sufficient to meet the growing demand of GG. TL is considering replacing its existing plant with a new Japanese plant. The production capacity of the new plant would be 50% more than the existing capacity. The board of TL considers this expansion a high-risk investment and requires a minimum expected rate of return of 15% on its investment.

To assess the viability of this decision, the following information has been gathered:
i) The purchase cost and installation cost of the new plant will amount to GH¢3.14 million and GH¢0.45 million, respectively.
ii) The supplier would send a team of engineers to Ghana for final inspection of the plant before commissioning at a cost of GH¢120,000. 50% of this cost would be borne by TL.
iii) As a result of the installation of the new plant, fixed costs other than depreciation would increase by GH¢0.3 million per annum.
iv) The existing plant has an estimated life of 10 years and has been in use for the last 6 years. The machine supplier has offered to purchase the existing plant immediately at GH¢1.6 million.
v) During the latest year, 6,000 units were sold at an average selling price of GH¢550 per unit. Variable manufacturing cost was GH¢450 per unit. TL expects to increase sales volume by 25% in the first year after the plant’s installation. Thereafter, the sales volume would increase by 4% per annum. Selling price and variable manufacturing cost will increase by 5% per annum.
vi) The new plant would be depreciated using the straight-line method. The residual value of the plant at the end of its useful life of 4 years is estimated at GH¢350,000.
vii) TL’s cost of capital is 12%.

Required:
Using break-even rate (internal rate of return), advise whether TL should acquire the new plant.

 

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  • 5 Marks

MA – Mar 2024 – L2 – Q1b – Divisional performance | Discounted Cash Flow

This question explains why the divisional manager may reject an option with a higher NPV and discusses board acceptability.

The performance bonus of the fragrance divisional manager is linked to Return on Investment (ROI) and Residual Income (RI) and has an impact on the calculation of retirement benefits. The manager is due to retire at the beginning of Year 3.

Required:
Explain why the fragrance Divisional Manager will not invest in the option showing the higher NPV and comment on whether it will be acceptable to the Board

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  • 15 Marks

MA – Dec 2023 – L2 – Q4a – Discounted Cash Flow

This question involves calculating the NPV for three projects being considered by Kanfa Ltd and recommending the best project based on financial grounds.

Kanfa Ltd received GH¢50 million as compensation from Ghana Highways Authority (GHA) when one of its properties was destroyed to pave way for the Accra–Kumasi highway construction. Management of Kanfa Ltd has decided to invest the amount received in one of three capital investment opportunities identified.

Project A:

This is a long-term project, which would run for 20 years and will require an immediate outlay of GH¢50 million and net annual cash profits as follows:

  • 1st to 5th years: GH¢2 million
  • 6th to 10th years: GH¢8 million
  • 11th to 15th years: GH¢15 million
  • 16th to 20th years: GH¢5 million

At the end of the 20th year, the project would be decommissioned at a cost of GH¢2 million.

Project B:

Kanfa Ltd is considering opening a Tourist Attraction Centre in Cape Coast, with an initial capital investment of GH¢50 million. It will operate for five years and be sold at an estimated price of GH¢5 million. The market research survey estimates the following visitor numbers and probabilities:

  • 800,000 visitors (30%)
  • 600,000 visitors (50%)
  • 400,000 visitors (20%)

Entrance fee: GH¢40 per visitor, and each visitor is expected to spend GH¢15 on souvenirs and GH¢5 on refreshments. Variable costs per visitor: GH¢25 (including souvenirs and refreshments). Maintenance costs: GH¢2 million per annum.

Project C:

This project involves a current outlay of GH¢50 million on equipment and GH¢15 million on working capital immediately. The working capital will increase to GH¢21 million in year one. Net annual cash profits: GH¢18 million for six years. The capital equipment can be sold for GH¢5 million at the end of the project.

Other information:

  • The company’s cost of capital is 12% for the three projects.
  • Ignore taxation and inflation.

Required:
Calculate the Net Present Value (NPV) of each project and recommend which project the company should undertake on financial grounds.

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  • 10 Marks

MA – Nov 2017 – L2 – Q1a – Discounted cash flow

Calculate the net present value of a new software game investment project and provide commentary on the findings.

a) Agyasco Ltd, a software company has developed a new game “Lando” which it plans to launch in the near future. Sales volumes, production volumes and selling prices for “Lando” over its four-year life are expected to be as follows:

Financial information on “Lando” for the first year of production is as follows: Direct material cost GH¢5.4 per game Other variable production cost GH¢6.00 per game Fixed costs GH¢4.00 per game.

Advertising costs to simulate demand are expected to be GH¢650,000 in the first year of production and GH¢100,000 in the second year of production. No advertising costs are expected in the third and fourth years of production. Fixed costs represent incremental cash fixed production overheads. “Lando” will be produced on a new production machine costing GH¢800,000. Although this production machine is expected to have a useful life of up to 10 years, Government legislation allows Agyasco Ltd to claim the capital cost of the machine against the manufacture of a single product. Capital allowances will therefore be claimed on a straight-line basis over four years.

Agyasco Ltd pays tax on profit at a rate of 30% per annum and tax liabilities are settled in the year in which they arise. Agyasco Ltd uses an after-tax discount rate of 10% when appraising new capital investments. Ignore inflation.

Required: Calculate the net present value of the proposed investment and comment on your findings.

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  • 10 Marks

MA – May 2018 – L2 – Q1a – Discounted cash flow

Compare the NPV of maintaining old equipment versus buying new equipment to advise management on the better option.

The Maintenance Manager of Prudence Ltd insists that management should maintain an old equipment that had been used for 5 years and is fully depreciated rather than buy a new one. The old equipment has a current operating cost of GH¢53,000.00 per annum. The operating cost of the equipment is expected to increase at 5% every year over the next four years, with a sale value of GH¢6,500.00 in the fifth year.

The Maintenance Manager has proposed, that a new system with enhanced technology to reduce operating cost to GH¢32,000.00 for the next three years and GH¢33,600.00 for the fourth and fifth years be introduced. The new equipment will cost GH¢60,000.00 and when introduced, a redundancy cost of GH¢25,000.00 will be paid, with the old equipment sold for GH¢12,000.00. The sale value of the new equipment will be GH¢10,200.00 after its five years’ useful life.

Required:
Using Net Present Value (NPV) method of capital appraisal with 20% cost of capital, advise management on which option Prudence Ltd should go for.

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  • 15 Marks

MA – July 2023 – L2 – Q4a – Discounted cash flow

Calculate the cost of capital for a delivery van investment using IRR, and compare payback and discounted cash flow methods of investment appraisal.

a) Johnson & Co is a medium sized company that is engaged in delivery services. As a result
of the recent increase in the demand for services, the Managing Director (MD) is planning
for the future business performance. The MD plans to acquire a delivery van at the cost of
GH¢85,000. The expected net cash flow per year are as follows:

The Sales Manager has indicated to the MD that he will recoup his investment in less than four years and for that reason, it’s a good investment.

The Management Accountant has however drawn his attention to the fact that the manager has not factored time value of money and the cost of capital in his analysis. He could not however suggest the cost of capital since financial institutions are charging different interest rates.

Required:

i) Calculate the cost of capital when used would result in a break-even, when the useful life of the van is five years with residual value of GH¢8,500. (11 marks)

ii) Using TWO (2) points each, compare and contrast the payback method of investment appraisal and the discounted cash flow method.

(4 marks)

 

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  • 11 Marks

MA – Nov 2020 – L2 – Q4a – Discounted Cash Flow

Calculate the cost of capital to break-even for a van investment over five years and discuss the advantages and disadvantages of the payback method.

a) Jayjay & Co is a medium-sized company that is engaged in delivery services. As a result of the recent increase in the demand for its services, the Managing Director (MD) is planning to acquire a delivery van at the cost of GH¢85,000. The expected net cash flow per year is as follows:

Year Net Cash Flow (GH¢)
1 25,000
2 28,000
3 39,000
4 34,000
5 24,000

The Sales Manager has indicated to the MD that the company will recoup its investment in less than four years, and for that reason, it’s a good investment. The Management Accountant, however, has drawn the MD’s attention to the fact that the Sales Manager has not factored in the time value of money and the cost of capital into his analysis.

Required:

i) Calculate the cost of capital that, when used, will make the investment break-even when the useful life of the van is five years with a residual value of GH¢8,500.
ii) Explain TWO (2) advantages and TWO (2) disadvantages of the payback method of investment appraisal and show how it compares to the discounted cash flow method.

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  • 6 Marks

MA – May 2020 – L2 – Q4b – Discounted cash flow

Explain the elements that determine the time value of money and its importance in investment appraisal.

b) The main reason why discounted cash flow methods of investment appraisal are considered theoretically superior is that they take into account the time value of money.

Required:

Explain THREE (3) elements that determine the time value of money and why it is important to take them into consideration when appraising investment projects. (6 marks)

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