AC 201 ASSIGNMENT 3

PART A Project valuation using Net Present Value - 40 marks, 10 marks for each of the four questions.

Sanjo Equipment has recently bought a new equipment for its business with the sum of $750, 000. The manager expects that the business will use it for five years and sell it for a scrap value of $200,000. If the required rate of interest is 5% and it is expected that the equipment will fetch the company the sum of $200,000 annually while costing $40,000 in annual expenses and assuming there is no working capital. Assume that the tax rate is 30%.

1. What is the Net Present Value of this project?
2. What is the Internal Rate of Return?
3. Should Sanjo buy the equipment or not?
4. What will happen if the required rate changes by 2% ( + and/or -)? (Hint: will the project still be viable if the required rate of return changes?)

PART B Present value of an annuity - Ordinary annuity, annuity due and annuity deferred - 40 marks, 5 marks each.

It was announced that your friend won a lottery worth $20,000,000 which will be paid at $1,000,000 for twenty years starting now. The required interest rate is 5% p.a.

1. What type of annuity starts paying immediately (Now/Year 0), i.e. at the beginning of the first period?
2. What is the present value of the annuity if the payment starts immediately?
3. Suppose that the payment starts at the end of the first year (Year 1, at the end of the first period). What type of annuity starts paying at the end of the first period?
4. What is the present value of the annuity in Question 3 above?
5. Your friend was of the view that since he plans to retire in two years from now, he wants his first payment to commence at the end of the second year. What type of annuity is this?
6. What is the present value of the annuity under this third option?
7. Your friend wished that the $1,000,000 payment would last forever, you told him that you could help him to value the cash flow of $1,000,000 paid in perpetuity. What value will you tell him?
8. Did your friend truly win $20,000,000? Explain.

(Hint: The types of annuity you need to understand are - Ordinary annuity, Annuity Due, Deferred Annuity and Perpetuity. A perpetuity is based on the formula of an ordinary annuity but it pays forever).

PART C Internal Rate of Return - 20 marks (10 marks each)

Your company is comparing two projects a feed mill and a flour mill and has calculated the internal rate of return of the projects to be 5% and 6% respectively.

1. How do you explain this to the management team in not more than 300 words? 20 marks
2. Which project should be taken? 10 marksAC 201 ASSIGNMENT 3

PART A Project valuation using Net Present Value - 40 marks, 10 marks for each of the four questions.

Sanjo Equipment has recently bought a new equipment for its business with the sum of $750, 000. The manager expects that the business will use it for five years and sell it for a scrap value of $200,000. If the required rate of interest is 5% and it is expected that the equipment will fetch the company the sum of $200,000 annually while costing $40,000 in annual expenses and assuming there is no working capital. Assume that the tax rate is 30%.

1. What is the Net Present Value of this project?
2. What is the Internal Rate of Return?
3. Should Sanjo buy the equipment or not?
4. What will happen if the required rate changes by 2% ( + and/or -)? (Hint: will the project still be viable if the required rate of return changes?)

PART B Present value of an annuity - Ordinary annuity, annuity due and annuity deferred - 40 marks, 5 marks each.

It was announced that your friend won a lottery worth $20,000,000 which will be paid at $1,000,000 for twenty years starting now. The required interest rate is 5% p.a.

1. What type of annuity starts paying immediately (Now/Year 0), i.e. at the beginning of the first period?
2. What is the present value of the annuity if the payment starts immediately?
3. Suppose that the payment starts at the end of the first year (Year 1, at the end of the first period). What type of annuity starts paying at the end of the first period?
4. What is the present value of the annuity in Question 3 above?
5. Your friend was of the view that since he plans to retire in two years from now, he wants his first payment to commence at the end of the second year. What type of annuity is this?
6. What is the present value of the annuity under this third option?
7. Your friend wished that the $1,000,000 payment would last forever, you told him that you could help him to value the cash flow of $1,000,000 paid in perpetuity. What value will you tell him?
8. Did your friend truly win $20,000,000? Explain.

(Hint: The types of annuity you need to understand are - Ordinary annuity, Annuity Due, Deferred Annuity and Perpetuity. A perpetuity is based on the formula of an ordinary annuity but it pays forever).

PART C Internal Rate of Return - 20 marks (10 marks each)

Your company is comparing two projects a feed mill and a flour mill and has calculated the internal rate of return of the projects to be 5% and 6% respectively.

1. How do you explain this to the management team in not more than 300 words? 20 marks
2. Which project should be taken? 10 mark