FIN2212E Financial Management

TUTORIAL
TOPIC: CAPITAL BUDGETING

1. Project A and B of equal risk are alternatives for expanding Rosa Company’s capacity. The
firm cost of capital is 13 percent. The cash flow for each project are shown below:

  Project A Project B
Initial Outlay (RM) (80,000) (50,000)
Year Expected cash flow (RM)
1 15,000 15,000
2 20,000 15,000
3 25,000 15,000
4 30,000 15,000
5 35,000 15,000

You are required to calculate the followings for both projects:

(a) Payback period. [Answer = 3.67 years, 3.33 years.]

(b) Net present value. [Answer = RM3,659.68, RM2,758.47]

(c) Internal rate of return. [Answer = 14.61%, 15.24%]

(d) Indicate which project you would recommend. Justify.

 FIN2212E Financial Management

2. Mr. A is considering investing $250,000 in a business. The cost of capital for the investment
is 13 percent. Following cash flows are expected from the investment:

Year Cash Flow ($)

0 (250,000)
1 50,000
2 100,000
3 200,000

Calculate the IRR for the proposed investment and interpret your answer. [Answer =
15.12%]
 FIN2212E Financial Management

3. Pegasus Bhd. is considering two mutually exclusive projects. The company’s cost of capital
is 10 percent. The project cash flows are summarized below

  Project A (RM) Project B (RM)

Initial Investment ( 79,510) ( 89,104)
Year  Cash Flow
1 19,810 22,108
2 19,810 22,108
3 19,810 22,108
4 19,810 22,108
5 19,810 22,108
6 19,810 22,108
7 19,810 22,108
8 19,810 22,108
9 19,810 22,108
10 19,810 22,108

You are required to choose only one project by adopt Payback Period.

Answer:
PP Project A = 4.01 years
PP Project B = 4.03 years
 FIN2212E Financial Management

4. Project B initial cost is RM600,000. It is expected to provide after-tax operating cash flow of
RM210,000 in year 1, RM150,000 in year 2, RM330,000 in year 3, RM350,000 in year 4,
and RM590,000 in year 5. The company expects to recover the initial costs in 4 years. The
cost of capital is 8 percent.

(a) What is the payback period of project B? Should project B be accepted? [Answer = 2.72
years]

(b) Calculate the NPV of project B. Should project B be accepted? [Answer =

RM643,814.44]
 FIN2212E Financial Management

5. You are considering two projects, Agro A and Agro B. The cost and cash flows for both
project are shown below. The required rate of return on both project are 12 percent.

Year Agro A (RM) Agro B (RM)

0 (50,000) (70,000)
1 12,000 13,000
2 12,000 13,000
3 12,000 13,000
4 12,000 13,000
5 12,000 13,000
6 12,000 13,000

Based on information given, calculate payback period for each project.

Answer:
PP Agro A = 4.17 years
PP Agro B = 5.38 years
 FIN2212E Financial Management

6. Botany Bay, a maker of casual clothing is considering four projects. Because of past
financial difficulties, the company has a high cost of capital at 15 percent.

Project A Project B Project C Project D

Initial Investment ($) 50,000 100,000 80,000 180,000
Year Cash Inflow ($)
1 20,000 35,000 20,000 100,000
2 20,000 50,000 40,000 80,000
3 20,000 50,000 60,000 60,000

(a) Calculate Net Present Value of each project.

Answer =

Project A Project B Project C Project D

Compute NPV ($) (4,335.50) 1,117.78 7,088.02 6,898.99

(b) Recommend which project should be select.

 FIN2212E Financial Management

7. Thomas Company is considering two mutually exclusive projects. The firm which has 12
percent cost of capital has estimated its cash flows as shown in the following table.

  Project A ($) Project B ($)

Initial Investment (130,000) (85,000)
Year  Cash Flow
1 25,000 40,000
2 35,000 35,000
3 45,000 30,000
4 50,000 10,000
5 55,000 5,000

(a) Calculate NPV of each project and access it acceptability.

[Answer = $15,237.71, $9,161.79]

(b) Calculate IRR of each project and access it acceptability.

[Answer = 16.06%, 17.75%]
 FIN2212E Financial Management

8. Purnama Enterprises is considering replacing a hand operated machine with new fully
automated machine. The company has two types of machine to choose and they are
mutually exclusive. Below are the expected cash flows of both machines:

  Panasonic LG
Initial Outlay (RM250,000) (RM260,000)
Year Expected cash flow
1 RM80,000 RM145,000
2 RM80,000 RM145,000
3 RM80,000 RM145,000
4 RM80,000 RM145,000

If the firm’s cost of capital is 12 percent, calculate the followings for both machines:

(a) Payback period.

PP Panasonic = 3.13 years.

PP LG = 1.79 years.

(b) Net present value.

Answer =

Panasonic LG
Compute NPV (RM) (7,012.05) 180,415.66

(c) Internal rate of return.

Answer =

Panasonic LG
Compute IRR (%) 10.66 42.09

(d) Indicate which machine that the company has to choose? Justify.
 FIN2212E Financial Management

9. The following information relates to three possible capital expenditure projects of a

company. Due to limited resources, only one project can be accepted.

Projects
A B C
Initial cost RM200,000 RM230,000 RM280,000
Expected life 5 years 5 years 5 years
Expected cash inflows
End year 1 RM80,000 RM100,000 RM55,000
2 70,000 70,000 65,000
3 50,000 50,000 95,000
4 60,000 50,000 100,000
5 55,000 50,000 40,000

The company assumes its cost of capital is 15 percent.

(a) Calculate the payback period for each project.

PP Project A = 3 years
PP Project B = 3.20 years
PP Project C = 3.65 years

(b) Based on answer on part (a), which project should be accepted? Why?

(c) Calculate the Net Present Value for each project

Answer=
Project A Project B Project C
Compute NPV (RM) 17,021.00 (3,791.11) (43,498.14)

(c) Based on answer on part (c), which project should be accepted? Why?
 FIN2212E Financial Management

10. White Cleaning Company has a 5-year maximum acceptable payback period. The firm is
considering the purchase of a new washing machine and must choose between two
alternative ones. The first machine requires and initial investment of RM25,000 and
generates annual after-tax cash inflows of RM6,500 for each of the next 8 years. The
second machine requires an initial investment of RM75,000 and provides an annual cash
inflow after taxes of RM9,500 for 15 years.

(a) Calculate the payback period for each machine.

Answer =
PP first machine = 3.85 years

PP second machine = 7.89 years

(b) Which machine should the firm accept? Why?

 FIN2212E Financial Management

11. Consider the following two mutually exclusive projects with cash flow given below:

Year Cash Flow (A) Cash Flow (B)

0 (RM210,000) (RM21,000)
1 RM15,000 RM11,000
2 RM30,000 RM9,000
3 RM30,000 RM11,000
4 RM370,000 RM9,000

If the firm’s cost of capital is 15 percent, calculate the followings for both projects:

(a) Payback period, and which project you choose? Why?

PP Project A = 3.86 years
PP Project B = 2.09 years

(b) Net present value, and which project you choose? Why?

Cash Flow (A) Cash Flow (B)

Compute NPV $57,001.98 $7,748.97

(c) Internal rate of return, and which project you choose? Why?

Cash Flow (A) Cash Flow (B)

Compute IRR 22.97% 32.73%

(d) Based on your answer in (a) through (d), which project will you finally choose?
 FIN2212E Financial Management

12. Your division is considering two projects with the following cash flows (in millions):

Year Project A ($) Project B ($)

0 -20 -13
1 5 8
2 9 7
3 12 3
NPV (WACC = 5%) $3.29mil $3.56mil
NPV (WACC = 10%) $0.99mil $2.31mil
NPV (WACC = 15%) ($0.96mil) $1.22mil

(a) What are the projects' NPVs assuming the WACC is 5 percent?
(b) What are the projects' NPVs assuming the WACC is 10 percent?
(c) What are the projects' NPVs assuming the WACC is 15 percent?
 FIN2212E Financial Management

13. Three independent projects are under consideration for capital budgeting purposes. Their
respective initial investment, cost of capital, and cash flows are provided below. Use the
following capital budgeting techniques to evaluate all three projects and indicate which
project should be undertaken, assuming there is no budget constraint.

Project 1 Project 2 Project 3

Initial Investment $120,000 $130,000 $150,000
Cost of Capital 9% 7% 10%
Target Payback period 4 years 4 years 4 years
Expected Cash Inflow ($)
1 30,000 33,000 35,000
2 30,000 33,000 35,000
3 30,000 33,000 45,000
4 35,000 30,000 45,000
5 35,000 30,000 45,000

Calculate:

(a) Payback period

PP Project 1 = 3.86 years

PP Project 2 = 4.03 years
PP Project 3 = 3.78 years

(b) Net present Value.

Project 1 ($) Project 2 ($) Project 3 ($)
NPV $3,481.32 $878.87 $3,230.03

(c) Internal rate of return.

Project 1 ($) Project 2 ($) Project 3 ($)
IRR 10.08% 7.26% 10.80%
 FIN2212E Financial Management

14. Star Industries is considering three alternative projects for the company's investment. The
cash flows for three independent projects are as follows: 

Year Project A ($) Project B ($) Project C ($)

0 (50,000) (100,000) (450,000)
1 10,000 25,000 200,000
2 15,000 25,000 200,000
3 20,000 25,000 200,000
4 25,000 25,000 -
5 30,000 25,000 -

Calculate the payback period for each project. If Star Industries has a four years’ payback
policy, which project will be accepted? Assume the three projects are independent.

PP Project A =3.2 years

PP Project B = 4 years
PP Project c = 2.25 years
 FIN2212E Financial Management

15. Quadrant is a highly geared company that wishes to expand its operations. Six possible
capital investments have been identified, but the company only has access to a total of
$620,000. The projects may not be postponed until a future period. After the projects end, it
is unlikely that similar investment opportunities will occur.

Expected net cash flows (including residual values) are:

Project Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

A (246,000) 70,000 70,000 70,000 70,000 70,000
B (180,000) 75,000 87,000 64,000 0 0
C (175,000) 48,000 48,000 63,000 73,000 0
D (180,000) 62,000 62,000 62,000 62,000 0
E (180,000) 40,000 50,000 60,000 70,000 40,000
F (150,000) 35,000 82,000 82,000 0 0

The cost of capital is 9 percent per year. Calculate Net Present Value for each project and
rank the project from highest to lowest.

Project NPV Ranking

A 26,275.59 1
B 11,453.24 5
C 9,799.94 6
D 20,862.63 2
E 20,699.28 3
F 14,446.90 4
 FIN2212E Financial Management

16. Carson Trucking is considering whether to expand its regional service center. The
expansion requires the expenditure of $10,000,000 on new service equipment and would
generate annual net cash flows from reduced costs of operations equal to $2,500,000 per
year for each of the next eight years. In Year 8 the firm will also get back a cash flow equal
to the salvage value of the equipment, which is valued at $1 million. Thus in Year 8 the
investment cash inflow totals $3,500,000. Calculate the project's NPV using each of the
following discount rates:

(a) 9 percent.

Compute NPV $4,338,914.07

(b) 11 percent.
Compute NPV $3,299,233.40

(c) 13 percent.

Compute NPV $2,373,085.60

(d) 15 percent.

Compute NPV $1,545,205.54

 FIN2212E Financial Management

17. The net cash flows associated with two projects are as follows (in $):

Year 0 1 2 3 4 5 6 Answer NPV

A (90,000) 0 30,000 40,000 45,000 50,000 50,000 60,326.81
B (60,000) 24,000 23,000 20,000 18,000 15,000 12,000 26,476.49

The required rate of return for both projects is 9 percent. Use NPV.

(a) If the projects are independent, which projects would be accepted?

(b) If the projects are mutually exclusive, which projects would be accepted?
 FIN2212E Financial Management

18. The following information relates to three possible capital expenditure projects of Hup Seng
Berhad. The relevant cash flow for each project are shown in the following table. The firm
cost of capital is 12 percent.

Projects
A B C
Initial cost RM200,000 RM235,000
RM280,000
Expected life 5 years 5 years 5
years
Expected cash inflows
End year 1 RM 80,000 RM100,000 RM
55,000
2 70,000 70,000 65,000
3 50,000 60,000 95,000
4 60,000 50,000 100,000
5 55,000 50,000 40,000

Based on mutually exclusive and capital rationing.

(a) Calculate Internal Rate of Return (IRR) for each project. Based on you answer, which
project(s) should be accepted?

A B C
Compute IRR 18.83 14.54 8.37

(b) Calculate the Net Present Value (NPV) for each project. Based on you answer, which
project(s) should be accepted?

A B C
Compute NPV 32,160.72 12,943.35 -25,207.25

(c) Based on your answer in i and ii, which project should be accepted.
 FIN2212E Financial Management

19. Country Wallpapers is considering investing in one of two mutually exclusive projects; E,
and G. The firm’s cost of capital is 15 percent. The firm has gathered the basic cash flow for
each project as shown in the following table.

Project E Project G
Initial Investment ($) 15,000 19,000
Year Cash Inflow ($)
1 6,000 4,000
2 6,000 6,000
3 6,000 8,000
4 6,000 12,000

(a) Calculate Payback Period (PP) for each project.

Payback Period Project E = 2.5 years.

Payback Period Project G = 3.08 years.

(b) Calculate Internal Rate of Return (IRR) for each project.

Project E Project G
Compute IRR 21.86 17.45

(c) Calculate the Net Present Value (NPV) for each project. Based on you answer, which
project(s) should be accepted?

Project E Project G
Compute NPV 2,129.87 1,136.29

(d) Based on your answer in i and ii, which project should be accepted. Justify
The net cash lows associated with two projects are as follows: KTC Ltd is currently an all
equity company and has an unlevered value of $100million. The
firm’s current cost of capital is 25%. Due to insufficient internal funding for KTC’s
upcoming projects the firm’s financial manager has decided to raise external funds of
$20million through debt borrowings at 10% interest rate. Its corporate tax rate is 30%.
Assume that the firm operates under the perfect capital market with corporate taxes as
argued by Modigliani and Miller. Determine KTC’s weighted average cost of capital if the
firm proceeds with raising external funds.
KTC Ltd is currently an all equity company and has an unlevered value of $100million. The
firm’s current cost of capital is 25%. Due to insufficient internal funding for KTC’s
upcoming projects the firm’s financial manager has decided to raise external funds of
$20million through debt borrowings at 10% interest rate. Its corporate tax rate is 30%.
Assume that the firm operates under the perfect capital market with corporate taxes as
argued by Modigliani and Miller. Determine KTC’s weighted average cost of capital if the
firm proceeds with raising external funds.