BUSF_A01.qxd

Suggested answers to selected problem questions

4.1 Barclay plc

Year Cash flow Factor Present value

£m £m

0 (10) 1/(1 +0.15)^0 (10.00)

1 5 1/(1 +0.15)^1 4.35

2 4 1/(1 +0.15)^2 3.02

3 3 1/(1 +0.15)^3 1.97

4 2 1/(1 +0.15)^4 1.14

Net present value 0.48

On the basis of NPV the project should be accepted since it is positive. On the basis of

discounted PBP it should be rejected because it does not pay back until year 4. For a wealth-

maximising business, the latter is not important.

4.3 Turners Ltd

(a) NPV

Year Discount Machine A Machine B

factor

Cash flows PV Cash flows PV

£ 000 £ 000 £ 000 £ 000

0 1.000 (120) (120.00) (120) (120.00)

1 0.909 40 36.36 20 18.18

2 0.826 40 33.04 30 24.78

3 0.751 40 30.04 50 37.55

4 0.683 20 13.66 70 47.81

5 0.621 40 24.84 50 31.05

Net present value 17.94 39.37

Machine B shows itself to be significantly more desirable from an economic viewpoint than

does Machine A. Since both machines have a positive NPV either would be worth buying.

(b) IRR

Clearly the IRR of both machines lies well above 10 per cent (the NPV at 10 per cent is fairly

large relative to the initial outlay).

For our second trial, 10 per cent (above) being the first, let us try 20 per cent.

Year Discount Machine A Machine B

factor

Cash flows PV Cash flows PV

£ 000 £ 000 £ 000 £ 000

0 1.000 (120) (120.00) (120) (120.00)

1 0.833 40 33.32 20 16.66

2 0.694 40 27.76 30 20.82

3 0.579 40 23.16 50 28.95

4 0.482 20 9.64 70 33.74

5 0.402 40 16.08 50 20.10

(10.04) 0.27

Chapter 4

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