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Can you advise where the NPV is coming from please ?
CheersExample 4
PQR plc is considering opening a new division to manage a new investment project. Forecast cashflows of the new project are as follows:
Year 0 1 2 3 4 5
Forecast net cash flow $m (5.0) 1.4 1.4 1.4 1.4 1.4PQR’s cost of capital is 10% pa. Straight line depreciation is used.
Required: Calculate the project’s net present value and its projected ROI and residual income over its five-year life.
NPV
Year 0 1 2 3 4 5
Forecast net cash flow $m (5.0) 1.4 1.4 1.4 1.4 1.4
Present value factors at 10% 1.00 0.91 0.83 0.75 0.68 0.62
Present value (5.0) 1.27 1.16 1.05 0.95 0.87
NPV = $0.30mROI
Year 1 2 3 4 5
1 Opening investment at net book value 5.0 4.0 3.0 2.0 1.0
2 Forecast net cash flow $m 1.4 1.4 1.4 1.4 1.4
3 Straight line depreciation (1.0) (1.0) (1.0) (1.0) (1.0)
4 Profit 0.4 0.4 0.4 0.4 0.4ROI (4 ÷ 1 x 100) 8% 10% 13% 20% 40%
Residual income
Year 1 2 3 4 5
Profit (as above) 0.4 0.4 0.4 0.4 0.4
Imputed capital charge (opening investment x 10%) 0.5 0.4 0.3 0.2 0.1
Residual income (0.1) 0.0 0.1 0.2 0.3Comment: this example demonstrates two points. Firstly, it illustrates the potential conflict between NPV and the two divisional performance measures. This project has a positive NPV and should increase shareholder wealth. However, the poor ROI and residual income figures in the first year could lead managers to reject the project. Secondly, it shows the tendency for both ROI and residual income to improve over time. Despite constant annual cashflows, both measures improve over time as the net book value of assets falls. This could encourage managers to retain outdated assets.
I do not know where you found this question, but you cannot be asked to calculate NPV’s in Paper P5 – it is not in the syllabus.
(Basic NPV’s are examinable in Paper F2, and more complicated in Paper F9 – but not in Paper F5).
its was here maybe this information is all given ie tables etc populated already, thanks a million anyway.
This is very bad of the ACCA.
It is a very old article that was actually when Paper F5 was called Paper 2.4 and then was a combination of F5 and F9 (and then NPV’s could be examined).
I know it says that it was updated in August, but they keep doing that – putting a new date when some or all of the article is not relevant!!They do not even give discount tables in Paper F5, and again NPV’s cannot be asked.
(Residual Income and ROI certainly can be asked, but not NPV)
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