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December 8, 2016 at 7:07 am
Hi Sir Moffat,
Couldn’t the company keep the $100 left over after investing in projects, as reserve for investing in the working capital for the year? Considering there might be higher inflation rates coming into play (although not a part of this practice question) which would mean the company might need some additional funds to buy materials in the upcoming years within the 3 year life of the project?
Kindly let me know your thoughts.
John Moffat says
December 8, 2016 at 7:47 am
If that were the case then you would need to be told, and then it would effectively be an extra investment opportunity.
December 8, 2016 at 6:56 am
Instead of calculating the NPV for all combinations of projects in case of non-infinitely divisible projects, can’t we simply rank the individual NPVs for the projects (similar to ranking used in the “infinitely divisible projects” case) and select the top 3 for adding up and getting the best possible combination?
I think it would save time of calculating the NPVs for all possible combinations. Please do let me know your thoughts.
No, you cannot rank by the profitability index if they are not divisible. There is no alternative but to look at each possible combination.
(If profitability index ever leads to the same result, then it is purely coincidence)
June 4, 2016 at 11:05 pm
Thanks for clarifying that for me John.
June 5, 2016 at 8:15 am
You are welcome 🙂
June 3, 2016 at 4:10 pm
I remember seeing a past question, cannot remember which year, where there were 5 projects to decide on investing and 3 of them were divisible and 2 were exclusively indivisible?
I am trying to recall what exclusively indivisible means. i think it means that if you produce one of the exclusive indivisible project you cannot produce the other?! I am not sure this is correct. Please clarify for me.
June 3, 2016 at 4:36 pm
The term is not ‘exclusively indivisible’ – it is ‘mutually exclusive’ and that does mean that if you do one of the projects then you cannot do the other.
May 10, 2016 at 8:12 am
Thanks for the great lecture. I am wondering wouldn’t the company be better off to use the cash surplus to decrease overdraft or other uses we went over in Cash management lecture instead of paying dividends?
May 10, 2016 at 9:56 am
If the cash is being borrowed, then they will not borrow it if they have nowhere to invest it.
If, on the other hand, they already have the cash available, then presumably they have a cash balance and not an overdraft, in which case they should give the money to shareholders.
March 3, 2016 at 3:00 am
On part C – Not infinitely divisible, when explaining that the remaining $100 can be given back to the shareholders as dividends, why specifically as dividends and not simply give it back?
Is there a reason for this?
Aren’t dividends paid from distributable profits?
Great lecture as always!
March 3, 2016 at 7:38 am
You can’t simply give money back to shareholders! The only way you give them money is by paying them a dividend.
Legally, you can only pay dividends out of profits that have been realised, but you need to have cash to pay it. The reason most companies do not pay out all their profits as dividends is because they retain and use the cash to expand the company. If they are not able to invest it profitably then they should pay more dividends.
March 5, 2016 at 5:20 pm
Thank you very much John!
Much appreciated! 🙂
March 5, 2016 at 5:33 pm
August 7, 2016 at 10:42 pm
I think your lectures are very clear and helpful. Thank you.
On the point regarding returning the $100 to the investors. If the money has not been borrowed to invest but is sitting in your bank, are you not still earning the cost of capital on that money? I understood that the cost of capital was either the cost of having that money you invested because you had to borrow it, or it was the money you could have made from it if it had just sat in the bank. In which case it would still be making some money?
August 8, 2016 at 8:06 am
The cost of capital is always the cost of raising money, and money is either raised from the shareholders (and we have the cost of equity) or borrowed from long-term bonds etc. (and we have the cost of debt) or both (and we have the WACC).
January 4, 2016 at 6:40 am
Hello john grt lecture, as usual.
However in part a when we had divisible projects the order of choosing them was D, C , A. This was before considering the divisibility.
So, the same can be considered as a rule for non divisibility projects as well right? Why do we consider total npv instead? And how does this make a difference?
Thank u sir.
January 4, 2016 at 7:57 am
No – the same rule cannot be used for non-divisible projects (and this is in fact explained in the lecture).
When they are divisible we are able to invest all of the capital available. However, when they are indivisible it is likely to not be possible to invest all of the capital and we have no choice but to simply look at the various combinations of projects available.
Our object always is to get the maximum NPV.
January 5, 2016 at 5:18 am
Ohh ok thnk u John 🙂
January 5, 2016 at 8:01 am
September 5, 2015 at 7:30 am
How i can download this video?
September 5, 2015 at 7:44 am
Lectures can only be watched online – it is the only way that we can keep this website free of charge.
August 28, 2015 at 2:27 am
Hi John, just wanna say thank u for the lecture notes and the videos that go with them, I found them to be very useful. I feel more confident now approaching the F9 Dec 2015 exam.
August 28, 2015 at 9:14 am
Thank you 🙂
March 16, 2015 at 12:35 pm
Regarding your example on part c (non-infinitely divisible) if we calculate NPV per invested $:
ABC NPV – 143 Total cost – 1400 NPV per $ – 0.102
ABD NPV – 157 Total cost – 1500 NPV per $ – 0.10466
ACD NPV – 143 Total cost – 1200 NPV per $ – 0.119
BCD NPV – 136 Total cost – 1300 NPV per $ – 0.10461
We should chose fraction ACD with highest NPV per $ at the same time we save (no borrow thereby less cost of capital) $400
My question is can I get on exam the same marks for this type of answer or is it better your answer ABD higher NPV?
March 16, 2015 at 1:01 pm
No – your answer would not get the marks.
We always want the highest total NPV, and the only correct answer is ABD.
Remember that the NPV is the surplus after repaying the borrowing (together with interest).
To explain, here is a very very basic illustration.
Suppose you could borrow $10 and get back $20 – a surplus of $10 ignoring interest.
Alternatively, you could borrow $100 and get back $120 – a surplus of $20 ignoring interest.
Which would you prefer? The first one gives surplus of $1 per $1 (10/10) and the second one only gives a surplus of $0.20 per $. (20/100).
However, surely you would prefer the second and end up with a surplus (cash profit) of $20 after repaying the borrowing as opposed to a surplus of only $10.
The only problem (and this is only relevant for a written part of a question) is that we are assuming that the returns are certain. If there is uncertainty then by choosing the second one we are taking more risk. However for the numbers part of questions we would always assume certainty.
March 16, 2015 at 1:31 pm
Thank you John!
That is clear.
March 8, 2015 at 9:56 pm
Now that the F9 exam has a multiple choice component, will it now be necessary to read the text book from cover to cover.
March 9, 2015 at 7:19 am
If you watch all our lectures (together with the lecture notes) then you will have enough to pass the exam well.
What is essential is that you have a current edition of Revision Kit and that you practice all of the questions.
October 23, 2014 at 6:16 pm
Hi Mr Moffat
Thanks to yourself and Open Tuition for the lectures.
A question regarding the answer to example 1(c) if I may (this question was asked by louise06111 back in Feb-12 but, and no disrespect to tameablebunchy, I’m not convinced by the answer given at that time, but I may be missing something).
The answer given to 1(c) in the lecture, is to choose the projects giving the greatest NPV, being A, B and D. However, A, C and D give the highest return per $ invested ($0.113 per $ invested compared to £0.105 per $ invested, if my maths are correct).
Using the same sort of logic, take this example (a spurious one but it’s simply to make the point):
A – cost $10000, NPV $1000
B – cost $2000, NPV $999
Assuming a capital restriction of $11000, and the projects are not infinitely divisible, A has the greater NPV, but B has much better return on investment. Surely B would be the better choice?
What am I missing?
Thanks again for the assistance you provide.
October 23, 2014 at 8:38 pm
The NPV is the cash surplus we end up with (after accounting for interest).
To take your examples, if you invest in project A then you end up with a cash surplus of $1000 (the amount not invested earns nothing.
If you take project B, then you end up with a cash surplus of $999 (the remaining $9,000 of the cash available earns nothing).
I would prefer to end up with a surplus of $1000 than a surplus of $999 🙂
(If we could invest all our money in B (i.e. 9.5 B’s) then certainly B would be better – we would end up with a much bigger cash surplus. However, that is not the case – we either invest in just one A or just one B)
October 24, 2014 at 9:17 am
Mr Moffat, thanks for replying.
Of course, the interest on the source of the capital in the first place (cost of capital) is already being accounted for in coming to the NPV, so choosing to ‘borrow’ the additional capital in the first place is the better option as it gives a greater NPV.
Knew I was missing something.
September 25, 2014 at 9:29 pm
What happens when the projects are mutually exclusive/ inclusive
September 26, 2014 at 7:54 am
If the projects were all mutually exclusive, it would mean that you could only do one of them – then you would simply select the project with the higher NPV.
If just 2 of them were mutually exclusive then you need to do the exercise twice. (If, for example, A and B were mutually exclusive, then you would do as normal first as though only A, C and D were available, and then as though only B, C and D were available. Whichever of the two solutions gave the higher NPV would be the best.
There is no such term as mutually inclusive. If they are all available, then it is the normal solution. I suppose what you could have (although extremely unlikely indeed for the exam) was that if, for example, we were to do A then we would be forced to do B. If that did happen, then you would treat A and B as being one project (simply adding them together) and then continue as normal. However, I do not think there is any chance at all of that being relevant for the exam.
September 30, 2014 at 1:17 am
Thanks John you are a star.
September 11, 2014 at 5:36 pm
Thank you for the lecture, it is really helpful.
September 11, 2014 at 6:22 pm
June 5, 2014 at 11:52 am
Could we in the exam say that the amount of 100$ leftover can be used as working capital in the projects so as to avoid the trap of fast expansion and working capital cash management?
May 27, 2014 at 7:31 pm
I have a question regarding investment appraisal,
When do I add Working Capital Recovery in DCF?.
I have noticed that some times it is added and sometimes it is just ignored.?
April 24, 2014 at 2:07 pm
Thank You So much Sir, An Excellent Lecture It Refreshed My memories Learning Limiting Factor Analysis and Throughput Accounting 🙂
December 1, 2013 at 9:26 pm
After listening to this lecture I finally fully understand capital rationing! Thank you for simplifying for me!!
November 24, 2013 at 12:14 pm
Thanks alot! The lectures are simple and easy to understand 🙂
July 17, 2013 at 2:22 pm
I feel am studying F5! It reminded me of key factor analysis and throughput accounting! Feels good that I still remember the stuff after the exam lol!
February 19, 2014 at 8:07 am
I’m studying F5 as well, so I’m finding F5+F9 an amazing combination 😀
November 20, 2012 at 6:45 am
Please assist.. Dec 2009…Q 3. I wanna calculate part a TERP not the way it has been calculated in the answer somebody let me know the other optional method we have..
June 28, 2012 at 11:19 am
it is really helpful, good points , good tutor
Miss A.. says
June 8, 2012 at 10:46 am
thnx a lot OT for making acca’s students life easier…
February 29, 2012 at 12:43 pm
thanks f9 has been eased for me instead of calming things i real understand the concept open tuition is far better than these colleges were we pay heavily and get sub standard lectures with out you i don’t know how i would have made it thankes
July 17, 2013 at 2:26 pm
Completely agree!!!! I have got no problem with paying money, in fact my study is half funded by my company, yet am so not gonna pay to have less quality lectures, that would be stupid! I can understand paying for a higher quality, but less quality! O.o! Opentuition is far better than the institute I was going to, it feels bad to be paying and then come to a free resource to understand everything you did not understand in the classes you have been paying for!!
February 25, 2012 at 12:24 pm
Regarding part(c) of Eg1, I am confused.
We choose ABD combination which gives the highest total NPV, but why don’t we analyse the efficiency as we do in part(b)?
ABC: 1400 input, we get 143 output, the efficiency is 10.21%;
ABD: 1500 input, 157 output, 10.46%;
ACD: 1200 input, 136 output, 11.33%;
BCD: 1300 input, 143 output, 11.00%.
(OMG, I hope I’ve made it clear~)
From my view I may think ACD is the most efficient investment combinations and I am wondering whether I got something wrong. Can you please help check my thought? Thx a lot.
February 25, 2012 at 7:56 pm
part B is infinitely divisible, this means you can do a fraction of a project, therefore you start with the highest NPV first and so forth what capital is left is invested into a fraction of the project B which 66.6666%.
With part C, capital is restricted to 1600 so you choose the best option that will return highest NPV per project because these projects are non infinitely divisible you have to choose the best option so you only have to borrow or use the amount of cash that is needed.
The key is to find the highest return/NPV for investment
February 26, 2012 at 2:37 am
Thanks a lot for your time and effort,
It does help!
November 29, 2011 at 1:33 pm
video lecture notes helpful but sometimes difficult to view.
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