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Hello Sir,For PYQ June 2009 Q5
PART a(ii)1)How is the NPV being found by the examiner?
I follow the examiner method which calculated for the overall plan and gets the different answer. (For the whole project of PO805,801,802)
2)part b
Why the maximum rate for the short term financing is based on those project which do not qualify for the current plan which generated a zero NPV?Why not based on the project chosen and the rate of borrowing should not exceed or equal to the return of the projects?
Please advise me if I’m wrong,Thanks.
1. The NPV’s for each project are given in the question. It is single period capital rationing and we approach it the same way as we did in Paper FM (was Paper F9). We rank them on the basis of the profitability index, which means we do P805 first, then we do P801. Doing all of those two projects takes up 740 investment. There is only 1,200 investment available and so there is only 460 left. The next best is P802, but to do it all would need 640. Therefore we can only do the fraction 460/640 of the project (or 71.875%)
2. We know from the first part of the question how the current funds available (1,200) will be invested, and that still stands.
If we want to do more then we will have to borrow more money, and the last sentence of the question says further funding will be at a higher rate. If is only worth doing the remaining projects if these remaining projects give a positive NPV. They will do so if the IRR of them is more than whatever the cost of the extra funding is.Oops, sorry for the mistake/typo,I mean its IRR and not NPV for(1), Which the answer using the DCF @14% and I found different NPV with the examiner, So how was it’s calculated?
Thank you for your explanation.I don’t know why you got a different NPV because I cannot see your workings!!
It is normal discounting!
The NPV of 805 is 7.3; of 801 is 14.2; and of 802 is (13.9)
Therefore the total NPV is 7.3 + 14.2 – (0.71875 x 13.9) = 11.5. I think the tiny difference is rounding, but I am not going to recalculate them to check 🙂
I don’t know why you got a different NPV because I cannot see your workings!!
It is normal discounting!
The NPV of 805 is 7.3; of 801 is 14.2; and of 802 is (13.9)
Therefore the total NPV is 7.3 + 14.2 – (0.71875 x 13.9) = 11.5. I think the tiny difference is rounding, but I am not going to recalculate them to check 🙂
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