NEUC Investment Berhad is to review two new proposals for spending money on specific projects. Since this is your first: Financial Management Report, MMU, Malaysia
|University||Multimedia University (MMU)|
Your first task as an employee at NEUC Investment Berhad is to review two new proposals for spending money on specific projects. Since this is your first assignment, you’re expected to not only give your opinion but also answer some questions to show that you understand how the process of deciding where to invest money works.
This is a standard procedure for all new employees at NEUC Investment Berhad. The outcome of this task will determine whether you directly join the department that analyses where to invest money or if you need some extra training first. The information about your task is in the message below: To: Financial Management Department From: Mr. Lim Yen, CEO, NEUC Investment Berhad Subject: Which projects should be chosen? Your job is to evaluate two projects that are being considered.
Both projects are expected to last for 5 years and will cost the same amount initially, which is RM110,000. Both of these projects are about adding to NEUC’s successful “Bubble Tea” product line. Because of this, the company has decided that the expected rate of return for these projects is 12 percent. The predicted amount of money the projects will generate, which we call “free cash flows,” is provided for each project below:
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- Project Chocolate Project Vanilla Initial Investment -RM110,000 -RM110,000 Cashflow Year 1 20,000 40,000 Cashflow Year 2 30,000 40,000 Cashflow Year 3 40,000 40,000 Cashflow Year 4 50,000 40,000 Cashflow Year 5 70,000 40,000 a. Why is the process of deciding where to invest money (capital budgeting) so important?
- Why is it not easy to find projects that make a lot of money or profits?
- How long does it take for each project to earn back its initial cost? If NEUC Investment Berhad only allows projects with payback periods of 3 years or less, which project should they choose?
- What are the problems with using the payback period to decide on projects?
- Calculate how much money each project will make after considering the time value of money. Should they approve either project based on this calculation?
- Explain why the calculation called Net Present Value (NPV) is a good way to analyze projects.
- Calculate the Profitability Index (PI) for each project. Should they pick either project based on this calculation?
- Do you think the NPV and PI calculations will always show the same projects as good or bad? Why or why not?
- How would the NPV or PI of the projects be affected if the required rate of return increased? What if the required rate of return decreased?
- Calculate the Internal Rate of Return (IRR) for each project. Should they choose either project based on these percentages?
- If the required rate of return increases/decreases, how will it affect the project’s IRR? You’re also asked to share your thoughts about another group of projects.
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