Question

Question 1. Issues in Capital Budgeting (30 marks-45 minutes) a. "Both the NPV and the IRR rules will always lead to the same decision being made irrespective of whether you are evaluating a capital investment project in isolation or two mutually exclusive projects." Critically discuss this statement. (5 marks) b. Your company is considering whether to invest in a new machine that costs R6m but will save the company R2.5m per year for the three years of its expected life. It will require an additional investment in inventory of R200 000, The marginal tax rate for companies 30% and depreciation for tax purposes is calculated on a straight line basis over three years. The machinery has an expected salvage value of R500 000. To keep the calculations simple, you decide to ignore inflation and use a real discount rate of 10%. Show that the machine project's NPV, IRR and 0 1 : Payback Periods are R83 621, 10.74% and 2.51 years respectively. 3 c. On the basis of the three values identified above only, should you do the project? Explain your (12 marks) 4 answer by explaining what these values calculated above mean from an decision making perspective. (6 marks) 6 d. Explain what additional work you might want to conduct to give you more confidence in your 17 18 19 20 decision. In your answer discuss why this work might help with the decision. (6 marks)

Answer 1

(A) Yes both The NPV and IRR are always leads to same decision making whether it is calculated in isolation or two mutually exclusive. As we know NPV is the diffrence between the Present value of cash outflow and cash inflow if the cash inflow is greater than cash outflow then it is good and the PV value is calculaled on the discount factor which we can say our required rate of return so it is not important f=phase that whether the project is mutually exclusive and isolation because if the project has NPV then both the projects are good to invest

similiarly IRR is to finad out the percentage of return on the basis of the amount paid and get in return so that the both PV of outflow and Inflow be same so this helps to find out the return percentage and then we can find that either it is beneficial to invest or not no matter depends the project are mutually exclusive or in isolation

NPV
year	1	2	3
Earnings	250000	250000	250000
less:- Dep	200000	200000	200000
Earnings after dep	50000	50000	50000
less:- tax	15000	15000	15000
Earning after tax	35000	35000	35000
ADD :- Dep	200000	200000	200000
CFATBD	235000	235000	235000
PVF @ 10%	0.909	0.826	0.751
PV OF Cash inflow	213636.36	194214.88	176558.98
total	584410.22
PV of salvage	375657.40
total cash inflow	960067.62
less :-cash outflow	600000.00
	360067.62
Less:- Cost of inventory	276000	(2lakh * 1.38)
NPV	84067.62
IRR calculation
Cash Inflow		PV@ 10%		PV @ 14%
year 1	213636.36	0.909	194214.88	0.877	187400.319
year 2	194214.876	0.826	160508.16	0.769	149442.041
year 3	176558.9782	0.751	132651.37	0.675	119172.281
year 3	500000	0.751	375657.40	0.675	337485.758
			863031.81		793500.40
Cash outflow
year 0	600000	1	600000		600000
year 0	200000	1	200000		200000
year 1 of intt on inventory cost	20000	0.909	18181.82		18181.82
	22000	0.826	18181.82		18181.82
	24200	0.751	18181.82		18181.82
			854545.4545		854545.455
			8486.36		-61045.06
			now on and avg basis we find 10.14%
Pay back period
	Cash outflow = 600000+66200
	Cash inflow 250000 per year
	2.48

yes i should accept the project because it gives the positive NPV

means this project gives ur=s the required return i decide it on the basis of Payback period NPV and IRR