ACCA F9 Financial Management

Questions for Discussion

Topic: Investment Appraisal (Discounted Cash flow Techniques)
ACCA Syllabus Section D Part 3

Net Present Value (NPV)

1 A machine will cost $80,000 and has an expected useful life of 4 years with a scrap value
of $10,000.
Expected net operating cash inflows each year are as follows:
Year Cash flow
1 20,000
2 30,000
3 40,000
4 10,000
The cost of capital is 10% per annum.

Required
Calculate the NPV of the investment and determine whether or not it should be
accepted.

2 The cash flows for a project have been estimated as follows:

Year Cash flow

0 (25,000)
1 5,000
2 10,000
3 8,000
4 6,000
The cost of capital is 6% per annum.

Required
Calculate the NPV of the project and determine whether or not it should be accepted.
3 LCH manufactures product X which it sells for $5 per unit. Variable costs of production
are currently $3 per unit, and fixed costs 50c per unit. A new machine is available which
would cost $90,000 but which could be used to make product X for a variable cost of
only $2.50 per unit. Fixed costs, however, would increase by $7,500 per annum as a
direct result of purchasing the machine. The machine would have an expected life of 4
years and a resale value after that time of $10,000. Sales of product X are estimated to
be 75,000 units per annum. LCH expects to earn at least 12% per annum from its
investments. Ignore taxation.

Required:
Decide whether LCH should purchase the machine.

4 A project costing $2,000 has returns expected to be $1,000 each year for 3 years at a
discount rate of 10%.

Required
(a) NPV using annuity tables
(b) Solely considering the annuity, what if the cash flows commenced in:
1. Year 4,
2. Year 6,
3. Year 0?

5 A company expects to receive $1,000 each year in perpetuity. The current discount rate
is 9%.

Required
(a) What is the present value of the perpetuity?
(b) What is the value if the perpetuity starts in 5 years?
 Internal Rate of Return (IRR)

1 Find the IRR of the project given below and state whether the project should be
accepted if the company requires a minimum return of 17%.
Time $
0 Investment (4,000)
1 Receipts 1,200
2 Receipts 1,410
3 Receipts 1,875
4 Receipts 1,150

2 Calculate the IRR of a project having the following details:

Time Cash flow
0 (1,500)
1-3 700

3 Find the IRR of an investment of $50,000 if the inflows are $5,000 in perpetuity.