What are the advantages of discounted cash flows methods?
Kiwanda Limited is considering the purchase of a new machine. Two alternative machines, Pesi TZO and Upesi MO2, which will cost Sh.6,000,000 and Sh.7,000,000 respectively are available in the market. The cash flow after taxation of each machine are as follows:
a) Compute the net present value of each machine. (8 marks)
b) Assuming that each machine represents a project:
Compute the return Kiwanda Limited expects to earn from each of the two projects. (10 marks)
Comment on the use of the results obtained in (a) and (b)(i) above in selecting between the two projects. (4 marks)
(Total: 22 marks)
The Weka Company Ltd. has been considering the criteria that must be met before a capital expenditure proposal can be included in the capital expenditure programme.
The screening criteria established by management are as follows:
No project should involve a net commitment of funds for more than four years.
Accepted proposals must offer a time adjusted or discounted rate of return at least equal to the estimated cost of capital. Present estimates are that cost of capital as 15 percent per annum after tax.
Accepted proposals should average over the life time, an unadjusted rate of return on assets employed (calculated in the conventional accounting method at least equal to the average rate of return on total assets shown by the statutory financial statements included in the annual report of the company.
A proposal to purchase a new lathe machine is to be subjected to these initial screening processes. The machine will cost Sh.2,200,000 and has an estimated useful life of five years at the end of which the disposal value will be zero. Sales revenue to be generated by the new machine is estimated as follows:
Year Revenue (Sh.’000’)
Additional operating costs are estimated to be Sh.700, 000 per annum. Tax rates may be assumed to be 35% payable in the year in which revenue is received. For taxation purpose the machine is to be written off as a fixed annual rate of 20% on cost.
The financial accounting statements issued by the company in recent years shows that profits after tax have averaged 18% on total assets.
Present a report which will indicate to management whether or not the proposal to purchase the lathe machine meets each of the selection criteria. (Total: 19 marks)
a) What are the features of a sound appraisal technique? (6 marks)
b) What practical problems are faced by finance managers in capital budgeting decisions? (6 marks)
c) Describe the features of long term investment decisions. (8 marks)
KK Ltd has six projects available for investment as follows:
Initial cost Sh.’M’
NPV @ 15% cost of capital
The firm has Sh.100 M available for investment.
Identify which projects should be undertaken. Using P.I and NPV ranking, comment on your answer.