Question

B would you prefer to invest in? Why? (5 marks) b) Mr. Said has to make a choice between two mutually exclusive investments Investment Cash flows (Shs '000) IRR (%) TO 1 T: х -800 500 600 22 Y -400 280 36 The opportunity cost of capital i 9% per annum. Mr. Said wants to invest in Y, which has the higher IRR. Do you agree with his choice? Show appropriate computations. (6 marks) Giving reasons, explain the expected financial risk and business risk in a mature business. (5 marks 358

Answer 1

answer b) INVESTMENT X

	year 0	year 1	year2
cash out flows	-800
cash inflows		500	600
	-800	500	600
ROR	9.0%
NPV	$ 150.21
IRR	23%

INVESTMENT Y

	year 0	year 1	year2
cash out flows	-400
cash inflows		280	358
	-400	280	358
ROR	9.0%
NPV	$145.14
IRR	36%

I disagree with his choice here investment Y has higher IRR of 36% as compared to Investment X of 23% but Investment X has higher NPV of $150.21 as compared to Investment X NPV of $145.14

therefore in case of contradicting results NPV should be given priority therefore Investment X is a better choice.

answer c)

Financial Risk

A company's financial risk is related to the company's use of financial leverage and debt financing, rather than the operational risk of making the company a profitable enterprise.

1.Financial risk is concerned with a company's ability to generate sufficient cash flow to be able to make interest payments on financing or meet other debt-related obligations. A company with a relatively higher level of debt financing carries a higher level of financial risk since there is a greater possibility of the company not being able to meet its financial obligations and becoming insolvent.

2.Some of the factors that may affect a company's financial risk are interest rate changes and the overall percentage of its debt financing. Companies with greater amounts of equity financing are in a better position to handle their debt burden. One of the primary financial risk ratios that analysts and investors consider to determine a company's financial soundness is the debt/equity ratio, which measures the relative percentage of debt and equity financing.

Debt/Equity Ratio = Total Liabilities / Shareholders' Equity

3.Foreign currency exchange rate risk is a part of the overall financial risk for companies that do a substantial amount of business in foreign countries.

Business Risk

1.Business risk refers to the basic viability of a business—the question of whether a company will be able to make sufficient sales and generate sufficient revenues to cover its operational expenses and turn a profit. These expenses include salaries, production costs, facility rent, and office and administrative expenses.

2.The level of a company's business risk is influenced by factors such as the cost of goods, profit margins, competition, and the overall level of demand for the products or services that it sells.

3.Business risk is often categorized into systematic risk and unsystematic risk. Systematic risk refers to the general level of risk associated with any business enterprise, the basic risk resulting from fluctuating economic, political, and market conditions. Systematic risk is an inherent business risk that companies usually have little control over, other than their ability to anticipate and react to changing conditions.

4.Unsystematic risk, however, refers to the risks related to the specific business in which a company is engaged. A company can reduce its level of unsystematic risk through good management decisions regarding costs, expenses, investments, and marketing. Operating leverage and free cash flow are metrics that investors use to assess a company's operational efficiency and management of financial resources.