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June 3, 2017 at 8:56 am #389855lusan
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The CABO company has decided to limit investment funds to $15m for the next year and is preparing its capital budget. The company is considering following project:
Net present value
All project have four year life. Project E,F,G,H and I are indivisible and project F and H are mutually exclusive
Information relating to future cash flows of this project is as follow:
The selling price per unit is $7 per unit which will inflate each year by 4%. The variable cost per unit is $5 which will be inflate each year by 2%. The fixed cost above is before taking account of inflation is whose inflation rate is same as variable cost. At the end of six years machinery from project will be sold for scrap with a value of $600,000. It can claim 25% reducing balance basis and pay tax at an annual rate of 30% one year in areas. CABO CO has nominal after tax cost of capital of 10% per year
(a) Calculate the nominal after tax net present value of project I and comment on financial acceptability of this project?
(b). Calculate the maximum net present value which can be obtained from investing fund of 15m? (Assuming that NPV is positive instead of negative)
a) Please review this question. I couldnot understand that at the end of year 6 machine will be sold at scrap $600,000. But in above we are said that it will have only four years. Please make it clear
b) question b has said us to calculate NPV but above given information is for Project I. can we use that information or not relating to invest fund $15mJune 3, 2017 at 10:05 am #389887John MoffatKeymaster
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(a) I have no idea why the machinery is not sold until the end of year 6. It seems as though it might be a typing error in the question, but if not then if it says 6 years you discount for 6 years.
(b) As regards the investment of the $15M, this is capital rationing and because the projects are indivisible you need to list all the various combinations that can be afforded, calculate the total NPV for each of them (the questions gives the NPV for all of them except for I and that one you calculate yourself), and then choose whichever combination gives the highest total NPV.
My free lectures on capital rationing will help you.
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