Question

a) Layang Indah Sdn Bhd is evaluating two (2) mutually exclusive projects. The cash flows in RM of each project are as follows: Year Project XX (RM) Project YY (RM) 0 500.000 600.000 1 50.000 200,000 2 150,000 200,000 3 250,000 200.000 4 200.000 200.000 5 100.000 200.000 The company's required rate of return is 10%. By using the following techniques in capital budgeting, which project should the Layang Indah Sdn Bhd undertakes and why? 0 Payback period Net present value (14 marks) b) The internal rate of return (IRR) for Project YY only. (Do Interpolation). (6 marks)

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Answer 1

Year Project XX Project YY 0 -RM5,00,000 -RM6,00,000 1 RM50,000 RM2,00,000 2 RM1,50,000 RM2,00,000 3 RM2,50,000 RM2,00,000 4 RM2,00,000 RM2,00,000 5 RM1,00,000 RM2,00,000 A. i) Payback Period Project XX Year Net Cash Flows Project YY Calculation Balance Year Net Cash Flows Calculation Balance -RM6,00,000.00 0 -RM5,00,000 -RM5,00,000.00 0 -RM6,00,000.00 1 RM50,000 --500000+50000 -RM4,50,000.00 1 RM2,00,000.00 =-600000+200000 -RM4,00,000.00 2 RM1,50,000 --450000+150000 -RM3,00,000.00 2 RM2,00,000.00 =-400000+200000 -RM2,00,000.00 3 RM2,50,000 = 300000+250000 -RM50,000.00 3 RM2,00,000.00 --200000+200000 RM0.00 4 RM2,00,000 --50000+200000 RM1,50,000.00 4 RM2,00,000.00 = 0 + 200000 RM2,00,000.00 5 RM1,00,000 =-150000+100000 RM2,50,000.00 5 RM2,00,000.00 =200000+200000 RM4,00,000.00

Payback Period: Payback Period: Year before full recovery + Balance amount to be recover at the start of the year Cash flow during the year If, Project has equal Cash inflows in all coming years, then use this formula: Initial Cash Outflow Payback Period Annual Cash Inflow 3 Years + RM50,000 RM2,00,000 = 3 Years + 0.25 RM6,00,000 RM2,00,000 3.25 Years 3 Years Decision : Project YY Payback period means the amount of time the project has taken to recover the initial cost/investment. Project which has shorter payback period are consider more prifitable, since investor want to recover invested amount as early as possible. Select Project YY: Project YY has shorter payback period. Initial outflow can be recover in 3 years.

ii) NPV Project YY Year Discounted Cash Flow Cash Flow Required Rate of Return is 10% Project XX Year Cash Flow Discounted Factor b C= 1 / 1.10 ^ a 0 -RM5,00,000 1 1 RM50,000 0.909090909 Discounted Cash Flow Discounted Factor C = 1 / 1.10 ^ a a a b -RM5,00,000.00 0 -RM6,00,000 1 -RM6,00,000.00 1 RM2,00,000 0.909090909 RM45,454.55 RM1,23,966.94 RM1,81,818.18 RM1,65,289.26 2 RM1,50,000 0.826446281 2 RM2,00,000 0.826446281 3 RM2,50,000 0.751314801 RM1,87,828.70 3 RM2,00,000 0.751314801 RM1,50,262.96 4 RM2,00,000 0.683013455 RM1,36,602.69 4 RM2,00,000 0.683013455 RM1,36,602.69 5 RM1,00,000 0.620921323 RM62,092.13 5 RM2,00,000 0.620921323 RM1,24,184.26 NPV RM55,945.01 NPV RM1,58,157.35 Decision : Project YY NPV method consider time value of money to evaluate projects.In NPV, expected cash flows to be receivable in future are discounted by using required rate of return and deduct such amount from initial investment of the project. If resulted amount is positive then project is profitable and company can go forward with such projects. Project YY has higher NPV compare to Project XX In, Mutually exclusive project, we can select only one projet from available projects. Hence,select the project which has high NPV Select Project YY : Project YY has higher NPV

B. Internal Rate of Return (IRR) Project YY IRR is the rate where NPV of the project is Zero. now find IRR by using interpolation Use 20% as discounting rate on trial and error basis Year Cash Flow Discounted Factor b c=1/1.2012 0 -RM6,00,000.00 1 a Discounted Cash Flow = b*C -RM6,00,000.00 1 RM2,00,000.00 0.833333333 RM1,66,666.67 2 RM2,00,000.00 0.694444444 RM1,38,888.89 3 0.578703704 RM1,15,740.74 4 0.482253086 RM2,00,000.00 RM2,00,000.00 RM2,00,000.00 NPV RM96,450.62 RM80,375.51 5 0.401877572 -RM1,877.57 Use Interpolation to find IRR 10% RM1,58,157.35 20% -RM1,877.57 10% RM1,60,034.93 Total NPV decrease (1,58,157.35-(-1,877.57))

If rate increase by 10% then NPV decrease in total by RM1,60,034.92 but, we only want to decrease in NPV RM1,58,157.35 RM1,60,034.92-----10% RM1,58,157.35-------? Do cross multiplication = 9.86% IRR is = 10% +9.86% = 19.86% IRR of the Project YY is 19.86%