Question 1. Issues in Capital Budgeting (30 marks-45 minutes) a. \"Both the NPV

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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)

Explanation / Answer

(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

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

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

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