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Capital Rationing Investment Analysis

Basril plc has Rs. 800,000 available to invest in one of three proposed projects: 1) Workstation assessments costing Rs. 300,000 with expected annual savings of Rs. 85,000-Rs. 100,000 over 5 years; 2) Individual workstations costing Rs. 450,000 with expected annual savings of Rs. 140,800 over 5 years; and 3) New ticket machines costing Rs. 400,000 with expected annual savings of Rs. 120,000 escalating by 3.6% annually over 5 years. Basril must determine the best investment project under the assumptions that the projects are either divisible or indivisible within the Rs. 800,000 budget using net present value

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Chirag Jain
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236 views1 page

Capital Rationing Investment Analysis

Basril plc has Rs. 800,000 available to invest in one of three proposed projects: 1) Workstation assessments costing Rs. 300,000 with expected annual savings of Rs. 85,000-Rs. 100,000 over 5 years; 2) Individual workstations costing Rs. 450,000 with expected annual savings of Rs. 140,800 over 5 years; and 3) New ticket machines costing Rs. 400,000 with expected annual savings of Rs. 120,000 escalating by 3.6% annually over 5 years. Basril must determine the best investment project under the assumptions that the projects are either divisible or indivisible within the Rs. 800,000 budget using net present value

Uploaded by

Chirag Jain
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd

CAPITAL RATIONING AND RELEVANT CASH FLOWS

Basril plc is reviewing investment proposals that have been submitted by divisional
managers. The investment funds of the company are limited to Rs.800,000 in the current
year. Details of three possible investments, none of which can be delayed, are given below.

Project 1
An investment of Rs.300,000 in work-station assessments. Each assessment would be on an
individual employee basis and would lead to savings in labour costs from increased
efficiency and from reduced absenteeism due to work-related illness. Savings in labour costs
from these assessments in money terms are expected to be as follows:

Year 1 2 3 4 5
Cash flows (Rs.000) 85 90 95 100 95

Project 2
An investment of Rs.450,000 in individual workstations for staff that is expected to reduce
administration costs by Rs.140,800 per annum in money terms for the next five years.

Project 3
An investment of Rs.400,000 in new ticket machines. Net cash savings of Rs.120,000 per
annum are expected in current price terms and these are expected to increase by 3·6% per
annum due to inflation during the five-year life of the machines.

Basril plc has a money cost of capital of 12% and taxation should be ignored.

Required:

(a) Determine the best way for Basril plc to invest the available funds and calculate the
resultant NPV:
(i) on the assumption that each of the three projects is divisible;
(ii) on the assumption that none of the projects are divisible.
(b) Explain how the NPV investment appraisal method is applied in situations where
capital is rationed.
(c) Discuss the reasons why capital rationing may arise.
(d) Discuss the meaning of the term ‘relevant cash flows’ in the context of investment
appraisal, giving examples to illustrate your discussion.

ASSIGNEMENT HOME 1

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