- 20 Marks
Question
a) Companies spend money in various ways through their annual budgets, which are usually planned. These spending cover both operational and investment-related decisions.
Required:
i) What are Capital Investment decisions? (2 marks)
ii) State THREE (3) areas that will be considered as capital investment spending or decision. (3 marks)
b) Mamaga Ltd manufactures household utensils in Ghana and is considering investing in a new aluminium smelting and moulding plant. This plant will have a useful life of 5 years but will cost GH¢400,000 to acquire and install, with a residual value of GH¢20,000. The plant will produce 100,000 units per year. Other estimates are given below:
- Selling price: GH¢30 per unit
- Direct cost: GH¢20 per unit
- Fixed cost (including depreciation): GH¢160,000 per annum
- Marketing and promotion cost: GH¢20,000 (Year 1) and GH¢32,000 (Year 2)
- Investment in debtors and stocks will increase in Year 1 by GH¢30,000 and GH¢40,000, respectively
- Creditors will also increase by GH¢20,000 in Year 1
- Debt, stocks, and creditors will be recouped at the end of the machine’s life
- The cost of capital is 18%
- Corporate tax is 25% and is paid in the year in which profits are made
- Depreciation is tax-deductible
Required:
Compute the Net Present Value of this project and advise Mamaga Ltd whether the plant should be acquired. (10 marks)
c) Financial markets provide platforms or mediums through which holders of surplus funds invest their funds. Those with financial deficits could raise funds or capital, enabling both parties to achieve their objectives.
Required:
Distinguish between money markets and capital markets giving an example of financial instruments traded in each type of market. (5 marks)
Answer
a)
i) Capital investment decisions involve the deployment of resources, both financial and non-financial, with the expectation of receiving larger sums of money or monetary rewards in the future. The initial financial outlay is significant, and the benefits accrue over several years.
(2 marks)
ii) The following are typical areas of capital investment decisions:
- Replacement of Equipment or Assets decision
- Expansion of company activities in the form of new products, branch networks, etc.
- Undertaking research and development
- Introduction of new products
- Purchase of new machinery or equipment
- Discontinuation of products or closure of units or subsidiaries
(Any 3 points @ 1 mark each = 3 marks)
b) NPV of Plant (Amounts in GH¢):
| Year | 0 | 1 | 2 | 3 | 4 | 5 |
|---|---|---|---|---|---|---|
| Sales | 3,000,000 | 3,000,000 | 3,000,000 | 3,000,000 | 3,000,000 | |
| Less: Direct Cost | (2,000,000) | (2,000,000) | (2,000,000) | (2,000,000) | (2,000,000) | |
| Contribution | 1,000,000 | 1,000,000 | 1,000,000 | 1,000,000 | 1,000,000 | |
| Less: Fixed Cost | (84,000) | (84,000) | (84,000) | (84,000) | (84,000) | |
| Less: Promotion | (20,000) | (32,000) | ||||
| Less: Depreciation | (76,000) | (76,000) | (76,000) | (76,000) | (76,000) | |
| Net Profit | 820,000 | 808,000 | 840,000 | 840,000 | 840,000 | |
| Add: Scrap Value | 20,000 | |||||
| Taxable Income | 820,000 | 808,000 | 840,000 | 840,000 | 860,000 | |
| Tax @ 25% | (205,000) | (202,000) | (210,000) | (210,000) | (215,000) | |
| PAT | 615,000 | 606,000 | 630,000 | 630,000 | 645,000 | |
| Add: Depreciation | 76,000 | 76,000 | 76,000 | 76,000 | 76,000 | |
| Working Capital | (400,000) | (50,000) | 50,000 | |||
| Net Cash Flow | (400,000) | 641,000 | 682,000 | 706,000 | 706,000 | 771,000 |
| DF @ 18% | 1 | 0.847 | 0.718 | 0.609 | 0.516 | 0.437 |
| Present Value | (400,000) | 542,927 | 489,676 | 429,954 | 364,296 | 336,927 |
NPV = (400,000) + 2,163,780 = GH¢1,763,780
c) Money Markets vs. Capital Markets:
- Money Markets: Short-term instruments are traded, typically with a tenor within one year. Examples include Treasury bills, commercial papers, certificates of deposit, and overnight deposits.
- Capital Markets: Long-term securities are traded, with a tenor beyond one year. Examples include government bonds, corporate bonds, and stocks.
- Topic: Financial markets
- Series: NOV 2021
- Uploader: Joseph