Answer All Questions

Question 1
Radeon Plc is considering investing in a machine which will cost 30000 and will give the following annual
income starting from year 1.

Year 1 5000
Year 2 7000
Year 3 10000
Year 4 15000
Year 5 8000

This project is expected to be funded by a loan at an interest rate of 7%.

Required

(a) Based on the NPV method, evaluate whether the company should invest in the machine.
(8 marks)
(b) Calculate the IRR of the project using a higher discount rate of 20%.

(9 marks)
(c) The NPV method of investment appraisal is better than the IRR method. Discuss this statement.
(3 marks)
(Total 20 marks)
Extract from the NPV table
DCF 7% DCF 20%
Y1 0.935 0.833
Y2 0.873 0.694
Y3 0.816 0.579
Y4 0.763 0.482
Y5 0.713 0.402

Question 2
The following information relates to Markfed and covers three consecutive accounting periods.
Income Statements for the years ended 30th June

2018 2019 2020

Credit Sales 100,000 120,000 130,000
Less Cost of Sales 65,200 63,900 64,050
Gross Profit 34,800 56,100 65,950
Less Wages 20,000 21,000 22,000
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 Office Expenses 6,000 7,000 8,000
Interest 2,500 2,000 1,500
Total Expenses 28,500 30,000 31,500
Net profit 6,300 26,100 34,450

Balance Sheets as at 30th June

2018 2019 2020

Cash at Bank 4,000 5,000 2,000
Debtors Control 6,000 9,000 9,000
Stock Control 13,500 15,000 17,000
20,000 25,000
Fittings 15,000
Premises 120,000 120,000 120,000
Total Assets 158,500 169,000 173,000

Creditors 9,000 15,000 13,000

10 year Loan from NDB 40,000 35,000 30,000
Shareholders Funds 109,500 119,000 130,000
Total Liabilities and Equity 158,500 169,000 173,000

Other information:
Net Cashflow from Operations 35,000 42,000 44,000
Credit Purchases 65,500 64,500 65,500

You are required to:

a. Calculate the following performance indicators

1 Gross Profit Margin
2 Quick Assets Ratio
3 Debtors Collection Period

(12 marks)
b. Write a brief report to the management of the company evaluating the performance of the company
over the 3 year period based on the above ratios.
(8 marks)
(Total 20 marks)

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Question 3
XYZ Ltd has the opportunity to invest in a project. The company has asked the finance manager to select
the best one out of two different projects since the company does not have sufficient funds to invest in both.
The following information is available.

Project 1: The cost is 42000 with a residual value of 6000 and a useful life of 6 years. The annual income
from this project will be 9000 during the first 2 years, 12000 during the next 2 years and 15000 during the
final 2 years.

Project 2: The cost is 25000 with a residual value of 5000 and a useful life of 4 years. The annual income
from this project will be 10000 each year from Year 1 to Year 4.

Required: Evaluate the two projects and recommend the best one based on
(a) The ARR method
(10 marks)

(b) Simple payback method

(7 marks)

(c) Discuss the relative merits of these two methods

(3 marks)
(Total 20 marks)

Question 4
Ultratune plc is a construction company that is funded 20% by debt and 80% by equity. The The following
data is available.

Ultratune’s debt beta 0.8

Ultratune’s equity beta 1.15
Risk free rate 10%
Return on the market 15%

(a) Calculate the cost of equity for Ultratune plc.

(6 marks)
(b) Calculate the cost of debt for Ultratune plc.
(6 marks)
(c) Calculate the Weighted Average Cost of Capital for Ultratune plc.
(6 marks)
(d) Briefly explain the purpose for a company of calculating its cost of capital

(2 marks)
.
(Total 20 marks)

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Question 5
A company manufacturing breakfast cereal has to decide whether or not to launch a new project. The
project is the introduction of a new type of cereal which will cost £600,000 to manufacture. Sales will
commence next year (year 1). Market analysts have forecasted that there is a 0.75 chance that the demand
for this product will be high and there is a 0.25 chance that the demand will be low. If the demand is high
the new product will generate additional sales of £850,000 and if the demand is low the additional sales
will be only £250,000. The cost of capital of the company is 12%.

Required:

(a) Depict the above scenario using a decision tree

(6 Marks)

(b) Calculate the total expected net present value of the new project. Based on your calculations should
the project be undertaken ?

(12 Marks)
(c) Discuss the pros and cons of the expected net present value approach to decision making.

(2 Marks)
(Total 20 marks)

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