MBA026: Corporate Finance

Trimester 2
End Term Re Examination
January 2022

Marks: 40 Max. Time : 2:00 hours

• Note: The question paper contains three parts, all parts are compulsory
• Do not write anything on the question paper except roll no.

Part A (5X2=10 Marks)

1. What is profitability index?

2. A friend needs Rs 50000 now, and will pay you back Rs 57000 in a year. Is that a good investment
when you can get 10% elsewhere?

3. Invest $2,000 now, receive 3 yearly payments of $100 each, plus $2,500 in the 3rd year. If the interest
rate is 10% ,calculate NPV?

4. Why is the payback method often considered inferior to discounted cash flow in capital investment
appraisal?

5. A project has an NPV of Rs12,632 when a discount rate of 12% is used and the same project has an
NPV of (Rs 6,935) when a discount rate of 22% is used, calculate the actual internal rate of return of the
project.

Part B (3X5=15 Marks)

6. The management of National company is considering three competing investments – investment P,

investment Q and investment R. The information about the requirement of initial amount of investment,
present value of net cash inflow and net present value of all three investments is given below:

Choose the most desirable proposal using present value index (profitability index).
7. OPPO is considering the following project: Cash Flows (Rs .in Millions)
C0 C1 C2 C3 C4 C5
-1,00,000 +22,600 +25,538 +28,858 +32,610 36,842
Assuming a cost of capital of 10% for C1 & C2, of 12% for C3 & C4 and 14% for C5. Should the project
be accepted?

8.A proposal to purchase a new machine is being considered by the management of HiTech manufacturing
company. The new machine would increase production and revenues. HiTech uses accounting rate of return
method to evaluate capital investments like this. The relevant data is given below:
Cost of new machine: $1,200,000
Useful life of the machine: 10 years
Expected annual cash inflows associated with the new machine: $450,000
Operating expenses associated with the new machine: $26,000
Salvage value of the machine at the end of 10-year period: $80,000

The expected annual cash inflows given above are the only revenue that the new machine will generate.
The operating expenses of $26,000 given above do not include the annual depreciation of the machine.
HiTech Company uses straight-line method of depreciation to depreciate all of its plant assets.

(a) Compute accounting/simple rate of return of the machine.

(b) Would HiTech Company purchase the machine if its desired accounting/simple rate of return is 20%?

Part C (15 Marks)

9. Adam Snaff is the owner and operator of Hot Diggity's Doggies. He sells hot dogs with all the appropriate
spices from a cart (A small, open, wheeled vehicle) on the streets of Metro City. He is considering three
alternative replacements for his existing vending cart. Each has a productive life of four years. They differ in
capacity and, hence, in the amount of revenue per day that each can generate. The initial cost, annual net cash
flow at the end of each year, and salvage value that will be realized at the end of the fourth year for each of the
replacement carts are listed below. Use this information to solve Problems 1 through 4.
Type of Cart Initial Cost Annual Net Revenue Salvage Value
Minicart $6 $2 $1
Midicart 8 3 1
Megacart 12 4 3

1. Calculate the net present value of each of the carts using a discount rate of 10%. Which cart is preferred?
2. Snaff has decided that the riskiness of profits from the three carts depends directly on the initial cost and
predicted annual net revenue from each. He believes that the appropriate risk-adjusted discount rates are
9%, 12%, and 15% for the Minicart, Midicart, and Megacart, respectively. Calculate the net present
value of each cart using the appropriate risk-adjusted rate of return for each. Which cart is preferred?
3. Calculate the internal rate of return of each of the three carts. Which is preferred?

4. Why is the preferred cart determined in Problem 1 different from that determined in Problem 3? Which is
the better approach (NPV or IRR) to use in this case? Why?