THE UNIVERSITY OF HONG KONG

MSC.(ENG.) MAY 2022 EXAMINATIONS

DEPARTMENT OF INDUSTRIAL AND MANUFACTURING SYSTEMS ENGINEERING

(IMSE7015) ENGINEERING ECONOMICS AND FINANCE

Important notices:
1. Answer ALL THREE questions. ALL three are compulsory. Workings are
required for the calculation parts. For the written parts, marks will be awarded
to writing clarity, including how the answer is structured and the clarity of the
explanations. Your answers must be in your own words.

2. This assessment is open book and to be attempted individually.

3. By submitting this assessment through Moodle, you declare that the submitted
assessment represents your own work and you have not committed plagiarism
and/or collusion in the submission. Cases of substantial similarities may lead to
a failing grade and disciplinary action.

(IMSE7015 – page 1 of 5)
Question 1

Excellence Ltd. is a manufacturing company.

The company conducts almost all its business operations in Country A, except that some of its raw
materials are sourced overseas from Country B. The currency of Country A is $ and that of Country
B is FC. The present exchange rate is 10 FCs to 1$.

Excellence is considering a 5-year project to launch a new product T1.

T1’s expected sales are 200,000 units per year, with a selling price of $40 per unit.

T1’s raw materials will be sourced from Country B. To produce each T1 unit, Excellence will have
to pay 100 FCs for the raw materials. The $ is expected to devalue by 5% per year against the FC
in the coming 5 years.

Besides raw materials, other variable costs of $22 will be incurred for each T1 unit. Fixed cost of
$430,000 per year is also expected.

A currently idle machine, after enhancements, can be used to produce T1. The idle machine’s
original cost to Excellence was $2,500,000, and if sold now, it can fetch about $1,300,000. The
enhancements will cost $400,000 at the commencement of the project. 在项⽬开始时

At the end of the project, the enhanced machine’s expected savage value is $100,000.

Working capital funding of $800,000 will also be required at the project’s beginning.

The company believes the risk of the T1 project and the risk of the company’s existing operations
are similar.

The company’s weighted average cost of capital is 10% pa.

Excellence pays profit tax in the same year at an annual rate of 20%. Tax allowable depreciation
should be ignored.

Required:

(a) Determine the net present value (NPV) of the T1 project. (20 marks)

(b) The NPV determined in (a) is based on the $ devaluing by 5% per year against the FC in
the coming 5 years. Determine the $-to-FC devaluation per year in the coming 5 years that
will result in a NPV of $0 in (a). (6 marks)

(c) The company is concerned whether its assessment that the T1 project and the company’s
existing operations have similar risks is accurate. Briefly describe approaches that could
help assess the risk of the T1 project. (6 marks)

(d) Based on the results in (a) and (b) above, as well as other calculations and information you
consider relevant, advise the company on whether the T1 project should be launched.
(8 mark)
(IMSE7015 – page 2 of 5)
Question 2

(a) Company S will be selecting from two mutually exclusive projects, X and Y.

The cash flows and the IRRs of the two projects are shown in the table below. Each project
has a 5-year useful life. The study period is also five years.

For both projects, no end-of-project salvage value is expected.

Project X Project Y
Initial investment ($) 11,000 12,500
Yearly net cash inflow ($):
Year 1 2,000 2,600
Year 2 3,000 3,600
Year 3 3,200 3,800
Year 4 3,400 4,000
Year 5 3,400 4,000

Project IRR 10.4% 12.6%

Required:
Determine the range of MARR where Project Y will be the project to adopt. (18 marks)

(b) Compare the net present value (NPV) method and internal rate of return (IRR) method as
an assessment tool to evaluate mutually exclusive alternatives. (Assume that all mutually
exclusive alternatives being evaluated have useful lives same as the study period.)
(12 marks)

(IMSE7015 – page 3 of 5)
Question 3

Top Tier Ltd. manufactures and sells electronic products.

During last year (20X2), the company launched a sales campaign to increase market share and as
a result, a significant growth in sales revenue was recorded.

The company’s financial statements for 20X2 and 20X1 are given on the next page. Additionally,
shown below are the amounts of some assets and liabilities at the beginning of 20X1:
• Accounts receivable $400,000
• Inventory $1,200,000
• Accounts payable $580,000
• Total assets $5,083,600
• Equity $2,930,000

Also available are the typical financial ratios of companies in the industry of Top Tier in 20X2
(20X2 industry averages, see table below).
Industry
average
20X2
Gross profit percentage (GP%) 16.0%
Return on total assets 13.0%
Current ratio 1.8
Acid test ratio 0.9
Average receivables days (days) 20
Inventory holding period (days) 50
Average payables days (days) 29
Debt to equity 1.0

All sales of the company are credit sales, and all the company’s purchases are credit purchases.

Required:
(a) Comment on Top Tier’s financial situation in 20X2. (23 marks)

(b) Looking ahead, Top Tier aims to expand further and is aware that the company will need
additional funding for the intended expansion. Top Tier’s current plan is to use only equity
funding to satisfy the additional funding requirement, and the company would like to know
what problems or issues may arise from their plan. Please advise. (7 marks)

(IMSE7015 – page 4 of 5)
Question 3 (cont’d)
Income Statement
For the year to 31 December ($'000) 20X2 20X1
Sales (all on credit) 14,000.0 10,440.0
Cost of sales -11,500.0 -8,280.0
Gross profit 2,500.0 2,160.0
Selling and administration expenses -1,591.0 -1,315.0
Profit before interest and taxation 909.0 845.0
Interest expenses -221.0 -201.0
Profit before taxation 688.0 644.0
Taxation (30%) -206.0 -193.0
Profit after taxation 482.0 451.0

Balance sheet as at 31 December ($'000) 20X2 20X1

Current assets
Cash 260.0 418.0
Inventory 1,531.0 1,440.0
Accounts receivable 1,565.0 720.0
3,356.0 2,578.0
Non-current assets - Plant and equipment, net 3,315.0 3,014.0
Total assets 6,671.0 5,592.0

Current liabilities
Accounts payable 1,062.0 792.0
Bank borrowing 700.0 340.0
1,762.0 1,132.0
Non-current liabilities – Bank borrowing 1,793.0 1,440.0
Total liabilities 3,555.0 2,572.0

Equity
Issued share capital 2,000.0 2,000.0
Retained profit 1,116.0 1,020.0
3,116.0 3,020.0

Total liabilities and equity 6,671.0 5,592.0

⎯ End of Paper ⎯

(IMSE7015 – page 5 of 5)