Question

A) Explain the concept of time value of money

B) Martin Co. is considering a project requiring Investment of $ 110,000 in equipment with a life of five years and a residual value of $ 15,000. Annual net cash flows will be $ 25,000, $ 37,000, $ 25,000, $ 21,000 and $ 10,000 for the five years respectively. According to the company policy, a project with a payback period of 2.5 years or less is acceptable. The company has a target accounting rate of return (ARR) of 10%

Required

1. Calculate the ARR based on average investment and advise whether the investment is financially acceptable

2. Calculate the payback period and advise whether the investment is financially acceptable

C) Musonda and Sons has a 15% cost of capital and is considering a project requiring initial investment of $ 350,000. Annual net cash flow will be $ 75,000 for the next 6 years.

Required

1. Calculate the NPV of the project and advise whether the investment is financially acceptable.

2. Calculate the IRR of the project and advise whether the investment is financially acceptable.

D) Briefly explain the objective of working capital management

Answer 1

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Part A
The time value of money is a basic financial concept that holds that money in the present is worth more than the same sum of money to be received in the future.
Time value of money is the concept that the value of a dollar to be received in future is less than the value of a dollar on hand today.
One reason is that money received today can be invested thus generating more money
Part b
Annual Depreciation		$                                      19,000
($110,000-$15,000)/5 Year
Calculation of Net Income:
		Year 1	Year 2	Year 3	Year 4	Year 5
Annual Net Cash Flow		$                                      25,000	$                 37,000	$       25,000	$   21,000	$   10,000
Less: Depreciation		$                                      19,000	$                 19,000	$       19,000	$   19,000	$   19,000
Net Income		$                                      44,000	$                 56,000	$       44,000	$   40,000	$   29,000
Average net Income	a	$                                      42,600
Average Investment	b	$                                      57,500
($110,000+$5,000)/2
ARR	a/b	74.09%
2. Payback Period
		Annual Net Cash Flow	Cummulative
Year 1		$                                      25,000	$                 25,000
Year 2		$                                      37,000	$                 62,000
Year 3		$                                      25,000	$                 87,000
Year 4		$                                      21,000	$               108,000
Year 5		$                                      10,000	$               118,000
Full Years+	(Amount to complete recovery in next year/Projected Net cash inflow in next year)
4 Full Years+	($2,000/$10,000)
4 Full Years+	0.20
4.2 Years
No Since it is more than 2.5 year
Part C
		PVAF 6%	Amount	PV
PV of $75,000		3.7845	$                 75,000	$     283,836
Outflow				$   (350,000)
NPV				$     (66,164)
Not acceptable as NPV is zero.
Year 0		$                                 (350,000)
Year 1		$                                      75,000
Year 2		$                                      75,000
Year 3		$                                      75,000
Year 4		$                                      75,000
Year 5		$                                      75,000
Year 6		$                                      75,000
IRR		7.69%
		IRR(C52:C58)
Part D
1. Ensuring smooth operating cycle of business.
2. Minimizing the cost of funds
3. Ensuring smooth availability of funds to enhance efficiency and profitability