Financial

management
Tutorial five: Investment appraisal -
Tutorial questions
ACADEMIC YEAR 2015-2016

Question One
LMN Ltd is considering the purchase of one of either two types of machines and they have forecast
the following costs and cashflows.

Machine 1


Machine 2
Year 0


(1,000,000)


(800,000)
Year 1


400,000


400,000
Year 2


500,000


400,000
Year 3


600,000


400,000
Year 4


600,000


300,000
Year 5


600,000


300,000
Year 6


600,000


250,000
Year 7


500,000


250,000

Required
Based on a discount rate of 11%, what machine should the accountant recommend using

a) Discounted payback.

b) Net present value.

c) Internal rate of return.


Question Two

The finance director of RTY plc is preparing financial plans for the next financial year and different
departments have submitted a number of applications for investment expenditure. He has been
informed by the managing director stating that no more than 1 million will be available for new
investment projects at the start of the next financial year. Cash flow forecasts for the investment
projects for which applications for investment expenditure have been made are as follows.

Year
Project 1
Project 2
Project 3
Project 4
0
(340,000)
(225,000)
(350,000)
(275,000)
1
105,000
75,000
90,000
115,000
2
110,000
75,000
90,000
115,000
3
115,000
75,000
140,000
115,000
4
110,000
75,000
140,000
115,000
5
105,000
90,000
140,000
nil

The cost of capital of RTY plc is 15% per year.

Required:

(a)
Discuss the reasons why the managing director of RTY plc may have limited the funds
available for new investment projects at the start of the next financial year, even if this
results in the rejection of projects which may increase the value of the company.


(b)
Determine the optimum investment schedule for RTY plc, and the net present value of the
optimum investment schedule, in the following cases:

i) The investment projects are divisible but not repeatable;
ii) The investment projects are not divisible and not repeatable

Question three


Allens Bratz Dolls PLC is an all equity company that has 100 million shares issued and the market
value of the company is 125 million. The company intends to raise 25 million, to be added to the
firms market capitalization, under a 1 for 4 rights issue.

Calculate the theoretical value of both the rights on

a) the new share

b) the value of the rights to each existing share.

Question four

What are pre-emptive rights and why are they advantageous to shareholders?

Question five

Discuss the advantages and disadvantages of a rights issue to a company.