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5URL Co has only $60,000 to invest in the following divisible projects. None of the projects are repeatable and can be delayed.
Year 0 Year 1 Year 2 Year 3 Year 4
A (50,000) (20,000) 20,000 40,000 40,000
B (28,000) (50,000) 40,000 40,000 20,000
C (30,000) (30,000) 30,000 40,000 10,000The cost of capital is 10%. Capital investment is made only in Year 0.
What is the approximate NPV from total investment (to the nearest whole number)?
Present value table (extracted)Year 1 = 0.909
Year 2 = 0.826
Year 3 = 0.751
Year 4 = 0.683a $63,084
b $56,800
c $62,310
d $44,230Answer – A
I watched your lecture on Investment appraisal – Methods and worked out all the problems from your notes as well. I am 100% understood on NPV. But, in this problem I have following doubts,
1. Company has only $60,000. But, how come it can be invested for three projects which total $ 108,000?
2. All the investments are made only in Year 0, then why the Year 1 reflects in negative? If the cash inflow shows negative then does it mean the company borrowed due to insufficient funds?I tried all the way but the answer did not come.
Thanks a lot for your time and effort
1. They are not investing in all the projects! They are ranking them in order of NPV per $ and then investing the $60,000 available.
2. The projects require investment at time 0 and at time 1 – that is perfectly acceptable. It is a time 0 that cash is limited and therefore if (for example) they decide to invest in only 50% of A at time 0, then automatically the investment at time 1 will be 50% as well.
You say you have watched the lectures on investment appraisal, but have you watched the lectures on capital rationing (in advanced investment appraisal)?
I tried this problem as my understanding with the help of your mentoring as above but, I couldn’t get the answer. Please help me out to resolve it.
Project NPV PI Rank $60,000 distributed
as investment
A 5,720.24 1.1144 3 Nil
B 3,316.16 1.1184 2 30,000
C 4,403.38 1.468 1 30,000After distributing the given investment,
Project C NPV = $-25,596.62
Project B NPV = $-26,683.84So, the NPV is $-52,280.46 (Negative).
Note & Questions:
1. I distributed the investment amount of $60,000 by rank to C is $30,000 (it became 60,000) & to B is $30,000 (it became $58,000) and no balance available for the project A.
2. The total investments of any project is not exceeded $60,000.
3. Why some of the cash inflows are reflecting as negative? What does it mean actually?
Thanks a lot,
What on earth are you doing?
Firstly, your first NPV’s (i.e. A 5720.24) are not quite correct. I can only assume you are calculating them on your calculator instead of using the discount factors that are given!
Secondly, why on earth are you deducting later the investment again? The NPV is after deducting all the outflows, but assuming that we invest in full. If we only invest in a fraction of a project then we only get that fraction of the NPV.
Thirdly, how on earth can you invest 30,000 in B when the maximum investment at time 0 is 28,000?
Fourthly, none of the inflows are negative!! A negative amount is a cash outflow, not an inflow.
You cannot possibly have watched my lecture on this, and if you are not prepared to watch the lectures then you cannot expect me to answer questions.
(Also, I have said before, that if you want to pass the exam you must buy a Revision Kit from one of the ACCA approved publishers. They contain exam standard questions (and some of those you have been attempting are clearly not exam standard) and they contain answers together with workings!)
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