THE ZAMBIA CATHOLIC

UNIVERSITY

NAME: CHONGO BLESSINGS

STUDENT ID: D21041

PROGRAMME: BACHELOR OF ARTS IN ECONOMICS

LECTURER: MR FRANCIS MUTEMBA

COURSE NAME: CORPORATE FINACIAL MANAGEMENT

COURSE CODE: ACC450

DUE DATE: 20/03/2024

Q1. (a.i) 1. Calculate the average investment

initial investment +residual value

average investment =
2

=K {(100,000+15,000)/2}

=K (115000/2)

= K57,500

2. Calculate the average annual earnings

Total cash earnings=K ( 25000+34000+25000+15000+ 8000 )

¿ K 107,000

total cash earnings

average annual earnings=
5

107000
¿
5

¿ 21,400

3. calculate ARR based on average investment

average annual investment

ARR= ∗100 %
average investment

21400
¿K[ ∗100 % ]
57500

¿ 37.22 %

(a.ii) To calculate AAR based on initial investment, we are going to divide the average annual
cash earnings over the 5 years by the initial investment then multiply by a 100%.

AAR= ( average annual earnings

initail inivestment )∗100 %
K 21400
¿ ∗100 %
100000

¿ 21.4 %
(a.iii) To calculate the payback period, there is need to determine the number of years it takes
for the cumulative cash earnings to equal or exceed the initial investment.

1. Calculate the cumulative earnings

Year 1 K0+K25000 K25,000

Year 2 K34000+K25000 K59,000
Year 3 K25000+K59000 K84,000
Year 4 K15000+K84000 K99,000
Year 5 K8000+K99000 K107,000

 Let number of years before initial investment is recovered = y

remaining investment
payback period= y+
cash flow∈the next year

1000
¿4+
8000

¿ 4 +0.125

¿ 4.125 years

(b.i) To calculate the IRR of the project for silver, we need to calculate first the net present
value of the project. So basically, we 2 net present values to find the internal rate of return.
Therefore, we start with (bii).

(bii)

fv∗1
pv=
( 1+ r )n

Initial investment= K183,000

Discounting rate= 25%

N= 4 years

Annual savings (cash flow) K70,000 for 4 years

Discounting year 1 Discounting year 2 Discounting year 3 Discounting year 4

0.8 0.64 0.512 0.410
 1 1
To discount the years the formular n was use i.e for example year 1:-
( 1+ r ) ( 1+ 0.25 )1

1
¿
( 1.25 )

¿ 0.8

Calculating NPV in excel we have;

year cash flow (K) discounting rate present value (K)

@ 25%
0 (-) 183,000 1 (-)183,000
1 70,000 0.8 56,000
2 70,000 0.64 44,800
3 70,000 0.512 35,840
4 70,000 0.41 28,700
NPV= -K17,660

(b.i) Since the NPV in (b.ii) is negative, we to reduce the discounting rate in order to find a
positive NPV.

year cash flow (K) discounting rate present value (K)

@ 15%
0 (-) 183,000 1 (-)183,000
1 70,000 0.87 60,900
2 70,000 0.7561 52,927
3 70,000 0.658 46,060
4 70,000 0.572 40,040
NPV= K16,927

Now that a positive NPV has been found, the two NPVs can be used to find IRR using the
formular: -

IRR=Lr+
[ npvl
npvl−npvh
∗( Hr−Lr )
]
¿ 15 %+ ¿

¿ 15 %+ ( 0.490∗10 % )

¿ 15 %+ 4.90 %

¿ 19.90 %
Q2. (a) Three features of a conservative policy in respect of financing working capital are:

High Liquidity Preference: Under a conservative policy, the company maintains a higher
level of liquidity by holding more cash and liquid assets than necessary to cover short-term
obligations. This ensures that the company can meet its financial obligations even during
periods of unexpected financial distress or economic downturns.

Low Leverage: A conservative working capital policy involves minimal reliance on short-
term borrowing to finance day-to-day operations. Instead, the company prefers to rely on
internal sources of funds, such as retained earnings, to finance its working capital needs. By
avoiding excessive debt, the company reduces its financial risk and interest expense.

Minimal Risk Exposure: Companies following a conservative working capital policy tend to
minimize their exposure to risks associated with liquidity shortages, such as late payments to
creditors or inability to fulfill customer orders. By maintaining a buffer of liquid assets, the
company can handle unforeseen events or changes in market conditions without jeopardizing
its operations or reputation.

(b) Main factors to consider when determining the policy in respect of investment and
financing working capital include:

Nature of Business: The industry in which the company operates and the nature of its
operations can influence its working capital needs. For example, industries with seasonal
demand may require higher levels of working capital during peak seasons.

Growth Opportunities: Companies planning for expansion or experiencing rapid growth

may require additional working capital to support increased sales, production, and inventory
levels. The working capital policy should align with the company’s growth objectives and
financing capabilities.

Cost of Capital: The cost of financing working capital, including interest rates on short-term
loans and opportunity costs of holding excess cash, should be evaluated. Companies aim to
minimize financing costs while ensuring adequate liquidity to meet operational needs.

Risk Management: Consideration should be given to the company’s risk tolerance and its
ability to manage risks associated with working capital, such as credit risk, liquidity risk, and
inventory management. The working capital policy should strike a balance between risk and
return.
Efficiency and Profitability: The working capital policy should aim to optimize the
company’s efficiency in managing its current assets and liabilities to maximize profitability.
This includes minimizing idle cash balances, reducing inventory holding costs, and
optimizing accounts receivable and payable turnover.

(c) In order to advise the finance director whether it is beneficial for the company to accept
the discount from dee limited, the present value of a future cash flow needs to be calculated.

Given:

 Cash discount rate; 5% (for payment within 10days)

 Short-term deposit interest rate; 18% per annum
 Invoice amount

1. calculate the cash discount

Cash discount =invoice amount∗discount rate

225,000∗5
¿K
100

¿ K 225,000∗0.05

¿ K 11,250

2. Calculate the interest earned on the short-term deposits for 10 days.

principal∗rate∗time
Interest =
365

¿
[ K 225,000∗ ( 100
18
)∗10 ]
365

K 225,000∗0.18∗10
¿
365

¿ K 12,328.77

3. Now to calculate the present value of the cash discount and compare it with the interest
earned on the short-term deposit.
 fv
Pv=
(1+ r )n

K 11,250
¿ 10
( 1+ 0.18 ) 365

K 11,250
¿
( 1.18 )0.0274

K 11,250
¿
1.0045454

¿ K 11,199.1

The value of the cash discount is approximately K11,199.1, comparing the present value of
the cash discount (K11,199.1) to the interest earned on the short-term deposit (K12,328.77), it
is more financially beneficial for MALU limited to keep the fund in the short-term deposit
rather than accepting the discount and paying early. Therefore, MALU limited should not
accept the discount on the purchase of material from DEE limited.

Q3. (a) To calculate the net present value (NPV), we need to find the present value of cash
flows associated with producing and selling the new camera and compare it with the
alternative of selling the patent.

The cash flows from producing and selling the camera are as follows:

 Initial outlay: K (840m + 210m + 2,820m) = K3,870 million

 Annual fixed costs: K1,035 million
 Annual variable costs: K4.2 million per camera * 800 cameras = K3,360million
 Annual revenue: K6 million per camera * 800 cameras = K4,800 million
 Salvage value of machinery: K480 million
 Discount rate: 12%

Therefore, net cash flow from year 1 to 3 will be;

net cash flow=annual revenue−¿ cost−variable cost

¿ K (4800 m−1035 m−3360 m)

¿ K 405 million

And the net cash flow for year 4 will be;

 net cash flow=annual revenue−¿ cost−variable cost+ salvage value

¿ K (4800 m−1035 m−3360 m+ 480 m)

¿ K 885 million

0 3870 1 3870
1 405 0.893 361.665
2 405 0.8 324
3 405 0.712 288.36
4 885 0.636 562.86
-2333.115

The NPV of producing and selling the cameras is -K2,233.12 billion while the NPV of selling
the patent is K780 million.

Therefore, the NPV of producing and selling the new camera versus selling the patent is (-
K2233.12 billion -K780 million= -K 3014.12 billion)

(b.i) we reduce the initial outlay on the machinery to K200 million

year cash flow (K) discounting fatcor @12% present value (K)
0 1250 1 1250
1 405 0.893 361.665
2 405 0.8 324
3 405 0.712 288.36
4 885 0.636 562.86
NPV= 286.885

Reducing the initial outlay on the machine automatically increases the NPV to K286.885
million.

(ii) the discounting rate reduced to 6%

year cash flow (K) discounting rate @ 0.1% present value (K)
0 3870 1 3870
1 405 0.99 400.95
2 405 0.98 396.9
3 405 0.971 393.255
4 885 0.961 850.485
NPV= -1828.41

(iii) the residual value of the machine increased from 480 million to 5500 billion
year cash flow (K) discounting rate @ 12% present value(K)
0 3870 1 3870
1 405 0.893 361.665
2 405 0.8 324
3 405 0.712 288.36
4 5980 0.636 3803.28
NPV= 907.305

Increasing the residual value of the machine from K480 million to K5500 billion increases
the NPV to K907.305 million

(iv) the annual operating cash flows increased

year net cash flows (K) discounting rate @12% present value (K)
0 3870 1 3870
1 1500 0.893 1339.5
2 1500 0.8 1200
3 1500 0.712 1068
4 1980 0.636 1259.28
NPV= 996.78

Increasing the annual operating cash flows to K1500 billion from K405 million increased the
NPV to K996.78 million.

(c) The NPV of producing and selling the cameras is negative which means that selling the
patent is a better option financially. Sensitivity analysis helps identify the factors affecting the
decision outcome significantly such as initial outlay, discount rate, residual value and annual
cash flow. This analysis provides insights into the project risk and help in making informed
decisions.

Q4.a) Break down the costs and savings

1. Current situation
Bad debts K8.75 million per year
Interest on overdraft K12% of K330 million
Current control department cost K6 million
2. Costs with debt factoring
Fee for taking over sales ledger 3% of turnover
Interest on advances 10%
3. Savings with debt factoring
Elimination of bad debts
 Reduction in credit period to 30 days
Savings from eliminating credit control department

Calculating each component

 Fee for taking over sales ledger

fee=3 %∗K 900 million
3
¿ ∗K 900 million
100
¿ 0.03∗900 million
¿ 27 million
 Interest on advances
Interest rate of 10% of 80% of trade debts outstanding
10 %∗80 %
10
∗80
100
¿
100
800
¿
10000
¿ 0.8
turnover
trade debts outstanding=
period annual
average credit period
k 900 million
¿
365 days
90 days
k 900 million
¿
4
¿ K 225 million
interest=0.8∗K 225 miilion
¿ K 18 million
 Savings from eliminating bad debts becomes K8.75 million.
 Saving from reducing credit periods might involve calculating the cost of financing
the extra 60 days of the credit for the current amount of trade debts outstanding. But
since the turnover is unlikely to change, this reduction in credit period doesn’t directly
affect cost or saving.
 Service from eliminating credit control department is K6 million per year.
  Interest on overdraft remains the same as before 12%
 Bank overdraft is K 330 million
12/100*K330 million = K39.6 million

Now to find to calculate the annual cost or savings to the business of employing the service
debt factor.

savings∈interest=interest on bank overdraft without factor −interest on bankoverdraft with factor

¿ K 39.6 million−K 18 million

¿ K 21.6 million

savings ¿ reduced credit period=

80
100 (
∗trade outstanding∗ 1−
10
100 )
¿ 0.8∗K 225 million∗0.9
¿ K 180 million∗0.9
¿ K 162 million

Therefore,

savings∨costs=savings∈bad debt+ savings interest + savingsfrom credit control department+ savings

¿ K 8.75 million+ K 21.6 million + K 6 million+ K 162 million
¿ K 198.35 million

(b) Debt factoring and invoice discounting are both methods of obtaining financing against
account receivables, but they both have some key differences.

DEBT FACTORING INVOICE DISCOUNTING

Involves selling accounts receivables to Involves using accounts receivables as
third party (factor) at a discount. collateral to secure a loan from a financial
institution.
The factor takes over the responsibility of The business retains control of collecting
collecting payments from customers. payments from customers.
The factor charges a fee for its service, The lender provides a loan based on the
mostly a percentage of the turnover. value of the outstanding.
The business may receive an advance The interest is charged on the amount
against the outstanding invoices typically borrowed.
 around 80%-90%.
Bad debts may be eliminated as the factor The business remains responsible for
assumes the risk of non-payment. managing credit control and collecting
payment from customer.

Q5.a) To evaluate the financial viability of the additional investment in the new machine, the
NPV of the project is to be calculated.

(i) Incremental revenue

Year 1 Year 2
Total demand -current production Total demand -current production
capacity* selling price per unit capacity* selling price @ 4% increase
= (150,000-100 000) *K15 000 per unit
= 50 000*K15 000 = (155 000-100 000) *K15600
=K750 million = 55 000*K15 600
= K858 million
Year 3 Year 4
Total demand -current production Total demand -current production
capacity* selling price @ 4% increase capacity* selling price @ 4% increase
per unit per unit
= (160 000-100 000) *K16224 = (170 000-100 000) *K16 872.69
= 60 000*K16 224 = 70 000*K16872.69
= K 973.44 million =K 1 181 107 200

(ii) Incremental variable cost

Year 1 Year 2
New demand -current production* New demand -current production*
variable cost variable cost @3% increase
= (150 000-100 000) * K5000 = (155 000-100 000) * K5150
= 50 000* 5000 = 55 000* 5150
= K 250 million = K 283.25 million
Year 3 Year 4
New demand -current production* New demand -current production*
 variable cost @3% increase variable cost @3% increase
= (160 000-100 000) * K5304.5 = (170 000-100 000) * K5463.635
= 60 000* 5304.5 = 50 000* K5463.635
= K 318.27 million = K 382.45 million

(iii) Increment in other production

Year 1 Year 2
New demand-current production*other New demand-current production*other
production cost production cost @ 3% increment
= (150 000-100 000) *K2000 = (155 000-100 000) *K2060
= 50 000*K2000 = 55 000*K2060
= K100million = K133.3million
Year 3 Year 4
New demand-current production*other New demand-current production*other
production cost @ 3% increment production cost @ 3% increment
= (160 000-100 000) *K2121.8 = (170 000-100 000) *2185.454
= 60 000* K2121.8 = 70 000*2185.454
= K100million = K153.0million

(iv) Incremental fixed cost

Year 1
K105 million
Year 2
K105million+ K10 million = K115 million
Year 3
K 115 million + 10 million = K125 million
Year 4
K 125 million + 10 million = K135 million
Scrap value is K100 million

Therefore, the net cashflows will be calculated as;

Net cash flow = incremental revenue-incremental variable cost-incremental fixed cost-

incremental other production costs
 Year 1 Year 2
K (750 million-250 million-100 million-105 K (858 million-283.25 million-113.3
million) million-115 million)
= K295 million = K346.45 million
Year 3 Year 4
K (973.44 million-318.27 million-127.308 K (1.184 billion-382.45 million-159.99
million-125 million) million-135million)
= K402.862 million = K513.67million+K100 million salvage
value =613.67 million

year cash flow (K) discounting rate @ 13% present value (K)
0 750 1 750
1 295 0.885 261.075
2 346.45 0.783 271.27035
3 402.862 0.693 279.183366
4 613.67 0.613 376.17971
NPV= 1187.708426

Since the NPV K1,187.71billion is positive, it is an indicator that the additional investment in
the new machine is financially viable under given assumptions.

(5.b) Basically, risk refers to the variability or dispersion of possible outcomes. In investment
appraisal, relates to the degree of uncertainty and the potential for loss. On the other hand,
uncertainty refers to a lack of knowledge about future events or outcomes. It implies
unpredictability and the different outcomes. While risk can be quantified and managed,
uncertainty is inherent and often difficult to mitigate.

(c) Limitations of NPV technique

I. Ignores timing of cash flow

It assumes that the cash flows occur at specific points in time and ignores the
timing of these cash flows within each period.
II. Ignores non-financial factors
It focuses solely on financial metrics and may overlook qualitative factors
such as market trends, competition and technological advancements.
III. Requires accurate data input
 The NPV calculations rely on input data such as cash flow estimates, discount
rates and project durations. Any inaccuracies in these inputs can lead to flawed
investment decisions.

REFERENCES

 Brealey, R. A., Myers, S. C., & Allen, F. (1988). Principles of corporate finance.
McGraw-Hill Education.
 Ross, S. A., Westerfield, R. W., & Jaffe, J. (1989). Corporate finance. McGraw-Hill
Education.
 Brigham, E. F., & Ehrhardt, M. C. (1979). Financial management: Theory & practice.
Dryden Press.
 Berk, J., & DeMarzo, P. (1991). Fundamentals of corporate finance. Pearson
Education.
 Clayman, M. R., Fridson, M. S., Troughton, G. H., & Scanlan, M. (2014). Corporate
finance: A practical approach. Wiley.