solution
solution.
Big Bang Ltd is considering to invest in one of the two following projects to buy a new equipment. Each equipment will last 5 years and have no salvage value at the end. The company’s required rate of return for all investment projects is 8%. The cash flows of the projects are provided below.
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Equipment 2 |
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Cost |
$186,000 |
$195,000 |
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Future Cash Flows Year 1 Year 2 Year 3 Year 4 Year 5 |
86 000 93 000 83 000 75 000 55 000 |
97 000 84 000 86 000 75 000 63 000 |
Big Bang’s net income in current year is $450,000.
The company maintains a capital structure of 55% in equity funding and 45% in debt funding. Required:
a) Identify which option of equipment should the company accept based on NPV method (3 marks) (Note: Please round up the result of each calculation of PV to 2 decimal places only for simplification)
b) Identify which option of equipment should the company accept based on Profitability Index method (2 marks).
c) Which equipment option should the company finally choose if the company is facing soft capital rationing? (1 mark)
d) How much dividend Big Bang Ltd can pay its shareholders given the chosen project you decided in question (c) and if the Residual Dividend Payout Policy applies? (1 mark)
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