AFE 2201 week 9 Corporate Finance

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2201 AFE Corporate Finance
Assignment
Weighting 20% of overall assessment
Due Monday 26th August 1:30pm

QUESTION ONE
ABC Ltd is considering an investment in new plant of $3 million. The project will be
financed with a loan of $2,000,000 which will be repaid over the next five years in equal
annual end of year instalments at a rate if 9 percent pa. Assume straight-line depreciation
over a five-year life, and no taxes. The projects cash flows before loan repayments and
interest are shown in the table below. Cost of capital is 13%. A salvage value of $200,000 is
included in the cash flow for year five. ABC Ltd paid $200,000 for a feasibility study on the
project about a year ago.
Year

Year One

Year Two

Year Three

Year Four

Year Five

Cash Inflow

900,000

950,000

800,000

950,000

900,000

You are required to calculate:
a. the amount of the loan repayments
b. repayment schedule showing the annual interest component in the repayments
c. NPV of the project
d. the IRR of the project
e. the annual equivalent benefit (AE or EAV)
f. the payback and discounted payback
g. the accounting rate of return (gross and net)
h. PI (present value index or profitability index, sometimes called benefit/Cost
Ratio)
Is the project acceptable? Why or why not? Your answer should include an
explanation of your treatment of the salvage value, the cost of the feasibility study,
and the interest and repayments on the loan.

QUESTION TWO
The Florina Mining Company has constructed a town at Jungilla, near the site of a rich
mineral discovery in a remote part of Australia. The town will be abandoned when mining
operations cease after an estimated 10 years. The following estimates of investment costs,
sales, and operating expenses relate to the project to supply Jungilla with meat and
agricultural produce over the ten year period by developing nearby land.
(a) Investment in land is $2million dollars, farm buildings $400,000, and farm equipment
$800,000. The land is expected to have a realisable value of $1 million in ten years’
time. The building have an estimated useful life of 20 years, at which time their
residual value would be zero, and they are to be depreciated on a straight line basis for
tax purposes based on this life. The residual value of the buildings after ten years is
$100,000. The farm equipment has an estimated life of ten years and a zero residual
value. The equipment is to be depreciated on a straight line basis.
(b) Investment of $500,000 in current. This will be recovered at the end of the venture.
(c) Annual cash sales are expected to be $6 million.
(d) Annual operating expenses are expected to be $4.4 million.
(e) Assume tax is paid one year after the year of income.
Is the project worth doing given that the after tax cost of capital is 10% pa, with a company
tax rate of 30%?

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