CHAPTER 4

THE INVESTMENT DECISION MAKING

PROCESS

BAIBF09013 ADVANCED PERFORMANCE MANAGEMENT

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QUESTIONS

1. $450 is invested in an account earning 6.25% interest p.a. Calculate the

a. Fund value after 12 years
b. Interest earned after 12 years

2. Calculate the present value of $25,000 receivable in six years’ time, if the interest rate is
10% p.a.

3. Calculate how much should be invested now in order to have $250 in eight years’ time?
The account pays 12% interest per annum.

4. Mickey Ltd is considering two mutually-exclusive projects with the following details.

Project A
Initial Investment : $450,000
Scrap value at the end of year 5 : $20,000
Cash flows from year 1-5 in $ : 200, 150, 150, 100, 100

Project B
Initial Investment : $100,000
Scrap value at the end of year 5 : $10,000
Cash flows from year 1-5 in $ : 50,40,30,20,20

Assume that the initial investment is at the start of the project and the annual cash flows
are at the end of each year.
Required
a. Calculate the Net Present Value for Projects A and B if the cost of capital is 10%.
b. Calculate the IRR of the project and advise the management on whether to proceed.
c. Calculate the Payback periods of these projects
d. Calculate the Accounting Rate of return of these projects

5. Find the IRR of a project with an initial investment of $1.5 million and three years of
inflows of $700,000 starting in one year.

6. Find the IRR of an investment that costs $20,000 and generates $1,600 for an indefinitely
long period.

7. Pluto Ltd has been offered a project costing $50,000. The returns are expected to be
$10,000 each year for seven years. Calculate the NPV and the IRR of the project if the cost
of capital is 10%.

8. An investment of $50,000 is expected to yield $5,670 per annum in perpetuity. Calculate

the NPV of the project if the cost of capital is 9%.

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9. A 5-year’ $600 annuity is starting today. Interest rates are 10%. Find the PV of the
annuity.

10. A perpetuity of $2,000 is due to commence immediately. The interest rate is 9%. What is
the PV?

11. What is the PV of $200 incurred each year for four years, starting in three years’ time if
the discount rate is 5%?

12. What is the PV of $300 incurred each year for 5 years, starting in four years’ time, if the
discount rate is 8%?

13. Calculate the present value of the following cash flows.

a. A fifteen year annuity of $300 starting at once. Interest rate is 6%.
b. A perpetuity of $33,000 commencing immediately. Interest rate is 22%

14. Calculate the IRR of an investment of $50,000 if the inflows are:

(a) $5,000 in perpetuity
(b) $8,060 for eight years

15. A company is considering a project with a three-year life producing the following costs
and revenues ($)
Cost of the machine 100,000
Depreciation of the machine for 3 years 20,000 per annum
Residual value of the machine 40,000
Annual cost of direct labour 20,000
Annual charge for foreman (10% apportionment) 5,000
Annual cost of components required 18,000
Annual net revenues from machines 80,000
Cost of capital 20%
Which of the following is closest to the net present value of the machine?

a. ($13,000)
b. ($11,380)
c. $11,610
d. $22,370

16. A potential project’s predicted cash flows give a NPV of $50,000 at a discount rate of 10%
and ($10,000) at a rate of 15%. Calculate the internal rate of return (IRR).

17. An expenditure of $2 million is expected to generate net cash inflows of $500,000 each
year for the next seven years. Calculate the payback period of the project.

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18. A project with the following cash flows is under consideration in a company called
Alpine Ltd ($)
T0 (20,000)
T1 8,000
T2 12,000
T3 4,000
T4 2,000
Calculate the MIRR at a Cost of Capital of 6%.

19. Michigan Ltd’s cost of capital is 9% per annum. A project with the following cash flows is
under consideration.
T0 T1 T2 T3 T4
($67,000) $20,000 $19,500 $19,000 $19,000

The MIRR for the project is closest to

a. 7%
b. 8%
c. 9%
d. 10%

20. An expenditure of @3.7 million is expected to generate net cash flows for 5 years as
follows. ($000)
T0 (3,700)
T1 1,200
T2 500
T3 1 800
T4 400
T5 3,100
Calculate the payback period of the project in years and months.

21. A company is considering a four year investment. Its cost of capital during this period is
expected to rise each year as interest rates and inflation rates rise in the economy.
It expects its cost of capital to be as follows.
Year 1 10%
Year 2 12%
Year 3 15%
Year 4 16%
Calculate the discount rate that should be used for each year.

22. An investment company is considering the purchase of a commercial building at a cost of

$0.85m. The property would be rented immediately to tenants at an annual rent of $80,000
payable in arrears in perpetuity. What is the net present value of the investment, assuming
that the investment company’s cost of capital is 8% per annum?

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23. A project has a normal pattern of cash flows (i.e. an initial outflow followed by several
years of inflows). Identify what would be the effects of an increase in the company’s cost
of capital on the internal rate of return (IRR) of the project and its discounted payback
period (DPP)?

IRR DPP
a. Decrease Decrease
b. Decrease Increase
c. No Change Increase
d. No Change Decrease

24. A company is to spend $60,000 on a machine that will have an economic life of ten years,
and no residual value. Depreciation is to be charged using the straight-line method.
Estimated operating cash flows are.
T $
1 -2,000
2 13,000
3 10,000
4-6 25,000 each year
7-10 30,000 each year

What is the average accounting of return (ARR), calculated as average annual profits
divided by the average investment?
a. 75%
b. 52%
c. 38%
d. 28%

25. A company is currently evaluating a project which requires investments of $12,000 now,
and $4,800 at the end of year 1. the cash inflow from the project will be $16,800 at the end
of year 2 and $14,400 at the end of year 3. The cost of capital is 15%.
Select the discounted payback period (DPP) and the net present value (NPV).
a. DPP: 2.00 years NPV: $6,000
b. DPP: 2.36 years NPV: $4,440
c. DPP: 2.00 years NPV: $4,440
d. DPP: 2.36 years NPV: $6,000

26. The Discount rate of company XYZ is 10%. Compute the discount rates to be used
assuming that the company receives/pays all cash flows
a. Quarterly
b. Bi annually
c. Monthly
d. Every 2 years

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