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MGT201 Financial Management Assignment 1 Solution Spring 2013

SNT Company is considering purchase of a new plant and machinery to supplement its manufacturing process. It has been anticipated that the new plant and machinery will involve an immediate cash investment of Rs. 500,000 and Rs. 8,000,000 in year 1. The after-tax cash inflows will be Rs. 150,000, Rs. 200,000 and Rs. 250,000 for year 2, 3 and 4 respectively. Afterwards, there will be a cash inflow of Rs. 300,000 each year from year 5 to year 10. Though the plant might be viable after 10 years but the company prefers to be conservative and end all calculations at that time. The company’s required rate of return is 14 percent.

Considering yourself as financial analyst of the company, you are required to make the following calculations along with interpretations:

a) What is the project’s payback period? Comment on the feasibility of project by considering that firm’s required payback period is 5 years.                                                      (3+1 Marks)

Payback Period = Years before recovery + (Uncovered Cost / Cash Flow from which the cost is to be covered)

pay back period is 6 years n 199 days

b) What is the net present value of the project? Is it acceptable?                           (5+1 Marks)

NPV Calculation

BY USING FORMULA:

NPV= [CFI/(1+I)^1 +CF2/(1+I)^2 +CF3/(1+I)^3+ ………….+CFI0/(1+I)^10]-INITIAL INVESTMENT

=[-800,000/(1+0.14)^1+ 150,000/(1.14)^2+ 200,000/(1.14)^3+………….+=300,000/(1.14)^10]-500,000

NPV= CALCULATED VALUE

IF NPV IS POSITIVE THEN ACCEPT THE  PROJECT OTHERWISE REJECT IT.
c) What is the internal rate of return for the project? Is it acceptable? Support your decision with conceptual rationale                                                                                               (8+2 Marks)

Solution:

calculate at r=11, r=12, r=13

So, IRR is somewhere b/w 11% & 12%

 

Rate                 NPV

11%                 NPV value1

X                     0

12%                 NPV value2

 

X / 0.01 = NPV1 / NPV1-NPV2

X = 0.01 * 0.833

X = 0.00833

 

IRR = 0.11 + 0.00833

= 11.833%

 


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