- This topic has 9 replies, 2 voices, and was last updated 4 years ago by
.
- Posts
Good Morning, I am sorry for typing out full questions like that as a comment on a lecture. Still trying to figure out how to use open Tuition. I do not have a full text of the book nor do I have the answers to the question I only have selected parts of the book given as power point slides so I do not have the solution to the question I asked. I shall take you advice and check for the Video on capital rationing and hope to understand in order to be able to resolve this assignment. I am sorry once again.
Chimymy.
If you are watching our lectures then you do not really need a text book. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
What you do need is a Revision Kit from one of the ACCA approved publishers. They are full of past exam and other exam-standard questions for practice, and practice is vital for passing the exam.
Good Evening Sir, I have questions concerning a question on Capital Rationing I am trying to solve
!. What odes it mean when its said the Cashflow does not allow for inflation yet the rate of inflation is mentioned(12%)
2. When some of the Cashflows have a negative sign what does the negative sign mean and should it be ignored in the calculations
3. When there is nominal rate expected by company shareholders does it represent the project investment rate?1. It means that the figures have to be inflated in order to arrive at the actual cash flows.
2. A negative sign means that it is a cash outflow, and it certainly should not be ignored.
3. No, it is the actual cost of capital that is used to discount the nominal cash flows.
All of this is explained in my free lectures.
I typed again as they appeared muddlled up. Three projects A,B,C.
A B C
0 310,000 – 115,000 – 36,000
1 96000(1.12) 45000(1.12)2 -41,000(1.12)3
2 113,000(1.12) 42000(1.12)2 – 23,000(1.12)3
3 210,000 (1.12) 47,000(1.12)2 127,000 (1.12)3The 2’s and 3’s outside the bracket represent the square and cube value of the interest rate it shows properly on microsoft word but when i transfered it here it appears as normal numbers or do I just multiply the the yearly outflows by the interest rate without multiplying by the square and cube values to arrive at the actual cash flows.
How am I supposed to to check when I have not seen the question?
The 12% is the inflation rate, not the interest.
If your first column (0, 1, 2, 3) are the years, then at time 1 there is 1 year inflation, at time 2 there are 2 years inflation, and at time 3 there are 3 years inflation.
Good Morning Sir, Please see below the question.
The directors of M &R plc wish to expand the company’s operations. However, they are not prepared to borrow at the present time to finance capital investment. The directors have therefore decided to use the company’s cash resources for the expansion programme.
Three possible investment opportunities have been identified. Only £600,000 is available in cash and the directors intend to limit the capital expenditure over the next 12 months to this amount. The projects are not divisible and none of them can be postponed. The following cash flows do not allow for inflation, which is expected
to be 12% per annum constant for the foreseeable future.
Expected net cash flows (including residual values)
Initial investment Year 1 Year 2 Year 3
Project £ £ £ £
A -310,000 96,000 113,000 210,000
B -115,000 45,000 42,000 47,000
C -36,000 -41,000 -23,000 127,000The company’s shareholders currently require a return of 16 per cent nominal on their investment. Ignore taxation.
Required
a) Explain how inflation affects the rate of return required on an investment project, and the distinction between a real and a nominal approach to the evaluation of an investment project under inflation.
b)
I. Calculate the expected net present value and profitability indexes of the three projects; and
II. Comment on which project(s) should be chosen for the investment, assuming the company can invest surplus cash in the money market at 10 per cent.
(15 marks)
c) Discuss whether the company’s decision not to borrow, thereby limiting investment expenditure, is in the best interests of its shareholders.Why are you attempting questions for which you do not have an answer? You should be using a Revision Kit from one of the ACCA approved publishers.
I explain part (a) in full in my free lectures.
For part (b) (i), again as I explain in my lectures, you inflate the year 1 flows by multiplying by 1.12, the year 2 flows by 1.12^2, and the year 3 flows by 1.12^3. You then discount in the normal way to calculate the NPV’s at 16%.
For part (b) (i) you calculate the profitability indexes in the way I explain in my lectures on capital rationing.
For part (b) (ii), since they are not divisible and since there is sufficient cash to do all three projects, they will do all projects with a positive NPV.
Part (c) is again explained in my free lectures.
Thank you so much Sir your response has helped me figure out the calculations am grateful. I would have pasted it here but not sure if you would like me to. Best Regards.
- The topic ‘capital Rationing’ is closed to new replies.