lOMoAR cPSD| 48745187
,UNIVERSITY EXAMINATIONS
OCTOBER/NOVEMBER 2024
EXAMINATION
FIN3701
Financial Management
70 Marks
Duration: 2 Hours
First Examiner: Dr LP Mamaro
External Examiner: Prof J Hall
,QUESTION 1 [10 marks]
Lemao Ltd, a large manufacturer of aircraft components, has a capital budget of R2 000 000 and is
evaluating the replacement of its existing machine with the more sophisticated model. The CFO determined
the initial investment required and the terminal cash flow associated with the replacement to be R1 666
000 and R254 000 respectively. Both the usable life of the proposed and the remaining life of the current
machine are 5 years.
Expected cash inflows relating to the investments are as follows:
Year Proposed machine Current machine
1 986 000 895 000
2 986 000 881 000
3 986 000 819 000
4 986 000 805 000
5 986 000 791 000
Lemao Ltd’s WACC is 15% and it is taxed at 28%.
REQUIRED
1.1 Calculate the incremental cash flows relating to the replacement decision. (6 marks)
1.2 Calculate the NPV and IRR relating to the two investments (using the incremental cash
flows calculated above). (2 marks)
1.3 Based on the NPV and IRR calculated above, would you advise Lemao Ltd to invest its funds in the
replacement? Provide a reason for your answer. (2 marks)
1.1 Calculate the Incremental Cash Flows
The incremental cash flows represent the difference between the cash flows of the proposed machine
and the current machine. This is calculated by subtracting the cash flows of the current machine
from the cash flows of the proposed machine for each year.
, Incremental Cash Flows (Proposed - Current)
Year Proposed Machine Current Machine Incremental Cash Flow
1 986,000 895,000 91,000
2 986,000 881,000 105,000
3 986,000 819,000 167,000
4 986,000 805,000 181,000
5 986,000 791,000 195,000
Now, add the terminal cash flow of the proposed machine to the Year 5 incremental cash flow:
• Terminal cash flow: R254,000
• Adjusted Year 5 incremental cash flow = 195,000 + 254,000 = R449,000
So, the adjusted incremental cash flows are:
Year Incremental Cash Flow
1 91,000
2 105,000
3 167,000
4 181,000
5 449,000
1.2 Calculate the NPV and IRR
To calculate the NPV and IRR, use the following:
1. Initial Investment = R1,666,000
2. Incremental Cash Flows (as calculated above)
,UNIVERSITY EXAMINATIONS
OCTOBER/NOVEMBER 2024
EXAMINATION
FIN3701
Financial Management
70 Marks
Duration: 2 Hours
First Examiner: Dr LP Mamaro
External Examiner: Prof J Hall
,QUESTION 1 [10 marks]
Lemao Ltd, a large manufacturer of aircraft components, has a capital budget of R2 000 000 and is
evaluating the replacement of its existing machine with the more sophisticated model. The CFO determined
the initial investment required and the terminal cash flow associated with the replacement to be R1 666
000 and R254 000 respectively. Both the usable life of the proposed and the remaining life of the current
machine are 5 years.
Expected cash inflows relating to the investments are as follows:
Year Proposed machine Current machine
1 986 000 895 000
2 986 000 881 000
3 986 000 819 000
4 986 000 805 000
5 986 000 791 000
Lemao Ltd’s WACC is 15% and it is taxed at 28%.
REQUIRED
1.1 Calculate the incremental cash flows relating to the replacement decision. (6 marks)
1.2 Calculate the NPV and IRR relating to the two investments (using the incremental cash
flows calculated above). (2 marks)
1.3 Based on the NPV and IRR calculated above, would you advise Lemao Ltd to invest its funds in the
replacement? Provide a reason for your answer. (2 marks)
1.1 Calculate the Incremental Cash Flows
The incremental cash flows represent the difference between the cash flows of the proposed machine
and the current machine. This is calculated by subtracting the cash flows of the current machine
from the cash flows of the proposed machine for each year.
, Incremental Cash Flows (Proposed - Current)
Year Proposed Machine Current Machine Incremental Cash Flow
1 986,000 895,000 91,000
2 986,000 881,000 105,000
3 986,000 819,000 167,000
4 986,000 805,000 181,000
5 986,000 791,000 195,000
Now, add the terminal cash flow of the proposed machine to the Year 5 incremental cash flow:
• Terminal cash flow: R254,000
• Adjusted Year 5 incremental cash flow = 195,000 + 254,000 = R449,000
So, the adjusted incremental cash flows are:
Year Incremental Cash Flow
1 91,000
2 105,000
3 167,000
4 181,000
5 449,000
1.2 Calculate the NPV and IRR
To calculate the NPV and IRR, use the following:
1. Initial Investment = R1,666,000
2. Incremental Cash Flows (as calculated above)
