BUSF_A01.qxd

Appendix 4 • Suggested answers to selected problem questions

lLevel of competition in the market.

lThe contract size, relative to the size of the business.

6.1 Easton Ltd

Different cash flows of Machine A

2,000 3,000 5,000

Year Demand Demand Demand

£££

0 (15,000) (15,000) (15,000)

1 (£4 –£1)/unit 6,000 9,000 15,000

2 6,000 9,000 15,000

3 6,000 9,000 15,000

Discounted: Factor £££

0 (1.00) (15,000) (15,000) (15,000)

1 (0.94) 5,640 8,460 14,100

2 (0.89) 5,340 8,010 13,350

3 (0.84) 5,040 7,560 12,600

1,020 9,030 25,050

Expected net present value =(0.2 ×1,020) +(0.6 ×9,030) +(0.2 ×25,050) =£10,632

Different cash flows of Machine B

2,000 3,000 5,000

Year Demand Demand Demand

£££

0 (20,000) (20,000) (20,000)

1 (£4 –£0.5)/unit 7,000 10,500 17,500

2 7,000 10,500 17,500

3 7,000 10,500 17,500

Discounted: Factor £££

0 (1.00) (20,000) (20,000) (20,000)

1 (0.94) 6,580 9,870 16,450

2 (0.89) 6,230 9,345 15,575

3 (0.84) 5,880 8,820 14,700

(1,310) 8,035 26,725

Expected net present value =(0.2 ×(−1,310)) +(0.6 ×8,035) +(0.2 ×26,725) =£9,904

A more direct route to expected net present values would be to take the ‘expected’

demand [(0.2 ×2,000) +(0.6 ×3,000) +(0.2 ×5,000) =3,200] and then find the NPV assum-

ing that level of demand.

6.2 Easton Ltd

(a) NPV

The expression for the NPV of this particular project may be put as follows:

NPV =D(S−V)Anr−I

Chapter 6

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