Questions and Answers of Corporate Financial Management

=+b the discounted payback;c the net present value.
=+What are the main objections to the use of payback? Why does it remain a very popu-lar method?
=+5" Maple ple is considering which of two mutually exclusive projects to accept, each with a five-year life. Project A requires an initial expenditure of £2,300,000 and is forecast to generate
=+What are the disadvantages of using ARR?
=+6 Explain why empirical studies show that, in practice, firms often prefer to evaluate projects using traditional methods.
=+7. Camelia ple has been run in an autocratic style by the chief executive and main share-holder, Mr Linedraw, during its 40-year history. The company is now too large for Mr Linedraw to continue
=+After the end of the fifth year this business activity will cease and no more cash flows will be produced.
=+3 Describe discounted payback.
=+8 Why is project screening necessary?
=+9 Invent five projects, each of which falls into a different project category.
=+10 Why are few projects rejected at the report stage?
=+12 Comment on the following statement:"The firm should choose the investment with a short payback rather than one with a larger net present value.'
=+1 For the following cash flows, calculate the payback and the discounted payback.Point in time 01 2p 42 45 67£€£(yearly intervals)500 500 500 500 A-3,000 500 500 500 B-10,000 2,000 5.000 3,000
=+3* (Examination level) Oakland ple is considering a major investment project. The initial outlay of £900,000 will, in subsequent years, be followed by positive cash flows, as shown below. (These
=+8 The making of good investment decisions is as much about understanding human psy-chology as it is about mathematics.' Explain this statement,
=+9 Explain how each of the following can lead to a sub-optimal investment process:a relying on top-down idea generation;
=+b managers being judged solely on accounting rate of return;a requirement that projects have a quick payback;
=+9 Describe the two major effects inflation has on the evaluation of investments.
=+10 Name two great 'don'ts' in inflation adjustment for projects and explain the conse-quences of ignoring these.
=+11 What will be the effect of under-allowance for future inflation when using a money dis-count rate?
=+1 The washer division of Plumber ple is permitted to spend £5m on investment projects at Time 0. The cash flows for five proposed projects are:Points in time (yearly intervals)0 12 34 Project Em
=+The cost of capital is 12 per cent, all projects are divisible and none may be repeated.The projects are not mutually exclusive.
=+a Which projects should be undertaken to maximise NPV in the presence of the capi-tal constraint?
=+b If the division was able to undertake all positive NPV projects, what level of NPV could be achieved?
=+c. If you now assume that these projects are indivisible, how would you allocate the available £5m?
=+2 The Telescope Company ple is considering five projects:Project Initial outlay Profitability index A6,000 1.2 B4,000 1.05 C10,000 1.6 D8.000 1.4 E7,000 1.3
=+Projects C and D are mutually exclusive and the firm has £20,000 available for invest-ment. All projects can only be undertaken once and are divisible. What is the maximum possible NPV?
=+3 The business insurance premiums of £20,000 for the next year have just been paid.
=+What will these premiums be in three years' time, if the specific rate of inflation for insurance premiums is 8 per cent per annum?
=+8 What are a balancing charge and a balance allowance for capital items subject to a writing-down allowance?
=+7 Why is capital rationing impossible in perfect capital markets?
=+d post-auditing once only, one year after completion;post-auditing conducted by managers from 'rival' divisions;over-optimism of project sponsors.
=+Visit www.pearsoned.co.uk/arnold for further questions, weblinks and an online glossary.
=+explain why capital rationing exists and be able to use the profitability ratio in one-period rationing situations;
=+show awareness of the influence of taxation on cash flows;
=+discount money cash flows with a money discount rate, and real cash flows with a real discount rate.
=+1 Explain why hard and soft rationing occur.
=+2 If the general rate of inflation is 5 per cent and the market rate of interest is 9 per cent,
=+what is the real interest rate?
=+4 Why not simply rank projects on the basis of the highest NPV in conditions of capital rationing?
=+5 Distinguish between a money cash flow and a real cash flow.
=+6 How should tax be allowed for in project appraisal?
=+If the money rate of return is 17 per cent and the general inflation rate is anticipated to average 9 per cent over three years, what is the present value of the insurance premi-ums payable at Time
=+Visit www.pearsoned.co.uk/arnold for further questions, weblinks and an online glossary.
=+3 Apply the technique of annual equivalent annuities to an asset which is replaced on a regular cycle. Consider alternative cycle lengths.
=+2 Examine some items of machinery (e.g. shopfloor machine tools, vehicles, computers).Consider whether to replace these items with the modern equivalent, taking into account increased maintenance
=+1 Try to obtain budgeted profit and loss accounts for a proposed project and by combin-ing these with other data produce cash flow estimates for the project. Calculate the NPV and contrast your
=+explain the time value of money and its components.
=+The production manager asks why you are discounting the cash flows. Briefly e
=+You are aware that the production manager gets very enthusiastic about new machinery and this may cloud his judgement. You suggest the third possibility, which is to continue production with
=+which machine should be selected.d
=+Calculate the annual equivalent annuities for Machines A and B and recommend C
=+Calculate the net present value of Machine B for its three-year life.
=+Machine A would have to be replaced by an identical machine on a two-year cycle. Machine B would be replaced by an identical machine every three years. It is considered reasonable to assume that
=+15 (Examination level) Hazel ple produces one of the components used in the manufac-ture of car bumpers. The production manager is keen on obtaining modern equipment and he has come to you, the
=+Choose the length of the replacement cycle which minimises the present values of the costs of an infinite number of cycles.
=+life after four years. These replacement cycles are expected to continue indefinitely. The management team believe that all such replacements will be for financially identical equipment, i.e. the
=+14" (Examination level) Opti ple operates a single machine to produce its output. The senior management are trying to choose between four possibilities. First, sell the machine on the secondhand
=+Calculate the best time to cut the trees given a cost of capital of 10 per cent.
=+13 Clipper owns 100 acres of mature woodland and is trying to decide when to harvest the trees. If it harvests immediately the net cash flow, after paying the professional log-gers, will be
=+12* Netq ple manufactures Qtrans, for which demand fluctuates seasonally. Netq has two machines, each with a productive capacity of 1,000 Qtrans per year. For four months of the year cach machine
=+Each machine will be replaced at the end of its life by identical machines with identical costs. This cycle will continue indefinitely. The cost of capital is 13 per cent.Which machine should
=+11 The Borough Company is to replace its existing machinery. It has a choice between two new types of machine having different lives, The machines have the following costs:Points in time (yearly
=+Help Curt ple to decide whether to produce widgets for itself. What other factors might influence this decision?
=+The discount rate is 16 per cent, and all cash flows occur at year ends except the initial investment.
=+The machinery has a life of five years and can be sold for scrap at the end of its life for £10,000. This is not included in the £88,000 for year 5. The installation of the new machine will
=+The managing director is convinced that the expertise for the manufacture of widgets exists within Curt. He therefore proposes the purchase of the necessary machine tools and other items of
=+10" The managing director of Curt ple is irritated that the supplier for the component widgets has recently increased prices by another 10 per cent following similar rises for each of the last five
=+Visit www.pearsoned.co.uk/arnold for further questions, weblinks and an online glossary.
=+8" The firm Reds plc in Question 7 has not yet purchased the new machinery and is con-sidering postponing such a cash outflow for a year or two. If it were to replace the existing machine now it
=+2 If possible, obtain data on a real project, historical or proposed, and analyse it using the techniques learned in this chapter.
=+Should Reds replace this new machine on a one -, two- or three-year cycle?
=+The values available from the sale of the machinery on the secondhand market are:Point in time (yearly intervals)0 12 3Secondhand value (E)8,000 6.500 3,500 Assume replacement by an identical
=+7* (Examination question if combined with Question 8) Reds ple is attempting to decide a replacement cycle for new machinery. This machinery costs £10,000 to purchase.Operating and maintenance
=+1 Try to discover the extent to which NPV, IRR and MIRR are used in your organisa-tion. Also try to gauge the degree of appreciation of the problems of using IRR.
=+6 Find the annual equivalent annuity at 13 per cent for the following cash flow:Point in time (yearly intervals)0 12 3Cash flow (€)-5,000+2,000+2,200+3,500
=+c.The board of directors have never been on a finance course and do not understand any of the finance jargon. However, they have asked you to persuade them that the appraisal method you have used
=+d Write a report for the managing director, detailing the value of the net present value method for shareholder wealth enhancement and explaining why it may be considered of greater use than IRR.
=+What would be the Internal Rate of Return on the project if MI did not have to pay for the licence?
=+The company's cost of capital is 12 per cent.Ignore taxation, inflation and exchange rate movements and controls.Required aCalculate the maximum amount MI should bid in the auction.b
=+Use the NPV decision rule to rank the projects and explain why, under conditions of mutual exclusivity, the selected project differs from that under (b).
=+ The Albanian government will make a one-off refund of 'administration' charges one and a half months after the end of the fifth year of 200,000.
=+h The project will require additional cash reserves of 1m to be held in Albania i throughout the project for operational purposes. These are recoverable at the end of the project.
=+b State which is the best project if they are mutually exclusive (i.e. accepting one excludes the possibility of accepting another), using IRR.
=+g During the whole of Year 3 a specialised item of machinery will be needed, which is currently being used by another division of MI. This division will therefore incur hire costs of £100,000 for
=+f The new equipment will have a resale value at the end of the fifth year of £1.5m.
=+The managing director has been on a one-day intensive course to learn about proj-ect appraisal techniques. Unfortunately, during the one slot given over to NPV he had to leave the room to deal with
=+The overheads contain an annual charge of £200,000 which represents an appor-tionment of head office costs. This is an expense which would be incurred whether or not the project proceeds. The
=+d The suppliers of materials and consumables grant a credit period of three months.e
=+The customers of MI demand and receive a credit period of three months.
=+b The initial lump sum payment has been excluded from the projected accounts as this is unknown at the outset.
=+The accounts department have produced the following projected profit and loss accounts.Year Projected profit and loss (Em)1 23 45 Sales 09 97 Less expenses Materials and consumables 0.6 0.4 0.5 0.5
=+7* Seddet International is considering four major projects which have either two- or three-year lives. The firm has raised all of its capital in the form of equity and has never borrowed money.
=+MI has already conducted a survey of the site which showed a potential productive life of four years with its new machine. The survey cost £300,000 and is payable immediately.
=+In addition to the lump sum the Albanian government will expect annual payments of £500,000 to cover 'administration'. If MI wins the licence, production would not start until one year later
=+5* (Examination level) Mines International plc The Albanian government is auctioning the rights to mine copper in the east of the country. Mines International plc (MI) is considering the amount
=+b Calculate the internal rate of return for each proposed project.
=+No inflation or tax.The cost of capital for Mercia is 10 per cent.It can be assumed, for simplicity of analysis, that all cash flows occur at year ends except those occurring at the start of the
=+Assume If the site was sold with no further work carried out it would fetch £100,000.-
=+The consultants recommend that the board of Mercia accept the second proposal and reject the first.

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