Question

As a project manager of UMBRELLA CORPORATION you are evaluating a new project, the cash flow of which appear as below, and that your company uses a require rate of return of 7% to evaluate on the project such as these: Year Cash Flows (RM20,000) RM5.000 RM4,000 RM6,000 RM7,000 RM8.000 FIN2102 (F) Page 3 of 4 i. What is the project's payback period? (4 marks) ii. What is the project's net present value? (5 marks) iii. Should your company accept the project? Why? (3 marks) (b) Emperor's Department Store is contemplating the purchase of a new machine at a cost of $17,000. The machine will provide $4,000 per year in cash flow for six years. King's has a cost of capital of 12 percent. Using the internal rate of return method, evaluate this project and indicate whether it should be undertaken. (8 marks) (c) The capital structure of Sunway Corporation consists of 30% common stock, 25% preferred stock and 45% debt. If the cost common equity for the firm is 12%, the cost of preferred stock is 9%, the before-tax cost of debt is 7%, and the firm's tax rate is 30% what is Sunway Corporation's weighted average cost of capital? (5 marks)

Answer 1

a]

(i)

Payback period is the time taken for the cumulative cash flows to equal zero

Payback period = 3 + (cash flow required in year 4 for cumulative cash flows to equal zero / year 4 cash flow) = 3 + (5,000 / 7,000) = 3.71 years

(ii)

NPV is calculated using NPV function in Excel.

NPV is 4,109.

(iii)

Yes, the company should accept the project as the NPV is positive.

A B C Cumulative 1 Year Cash Flow Cash Flow 0 (20,000) (20,000) 5,000 (15,000) 4,000 (11,000) 6,000 (5,000) 7,000 2,000 8,000 10,000 8 NPV 4,109

в 1 Year 2 0 3 1 42 5 3 6 4 Cash Flow -20000 5000 4000 6000 7000 8000 =NPV(7%,B3:B7)+B2 Cumulative Cash Flow =B2 =C2+B3 =C3+B4 =C4+B5 =C5+B6 =C6+B7 75 8 NPV