Question

QUESTION ONE CB

(a) Mwongozo Limited has approached you for advice on an equipment to be purchased for use in a five year project.

The investment will involve an initial capital outlay of Shs. 1.4 million and the expected cash flows are given below:

Year	Cash inflows	Cash outflows
	Shs.	Shs.
1	800,000	65,000
2	750,000	80,000
3	900,000	50,000
4	1,200,000	55,000
5	1,100,000	70,000

The equipment is to be depreciated on a straight line basis over the duration of the project with a nil residual value.

The cost of capital and the tax rate are 12% and 30% respectively.

Required:

1. The net present value (NPV) of the investment.
2. The profitability index (P.I) of the investment
3. The internal rate of return (IRR) of the investment

Answer 1

A. NPV of the investment:

Years	Cash Inflow	Cash Outflow	Depreciation	Net Profit	Net Profit after Tax	Net Cash Flow including Depreciation	Discounting factor at 12%	NPV
0	0	(1,400,000)	-	(1,400,000)	(1,400,000)	(1,400,000)	1	(1,400,000)
1	800,000	(65,000)	(280,000)	455,000	318,500	598,500	0.8929	534,375
2	750,000	(80,000)	(280,000)	390,000	273,000	553,000	0.7972	440,848
3	900,000	(50,000)	(280,000)	570,000	399,000	679,000	0.7118	483,299
4	1,200,000	(55,000)	(280,000)	865,000	605,500	885,500	0.6355	562,751
5	1,100,000	(70,000)	(280,000)	750,000	525,000	805,000	0.5674	456,779
TOTAL	1,078,052

B. Profitability index

= Present Value of future cash flows / Intitial Investment

= 2478052/ 1400000

= 1.77

C. The IRR of the investment is 37.52%.

We can arrive at the same by using the formula =IRR(values) in Excel