Question

JK Products is evaluating an investment in either of two competing projects that will allow the company to eliminate a production bottleneck and meet the growing demand for its products. The company’s engineering department narrowed the alternatives down to two –MD and HD. A project specialist developed the following estimates of cash flows for MD and HD over the relevant six-year time horizon. The company has an 11% required return and views these projects as equally risky.

	Project MD	Project HD
Initial Outflow (CF0)	R670,000	R940,000
Year (t)	Cash Inflows (CFt)
1	R250,000	170,000
2	200,000	180,000
3	170,000	200 000
4	150 000	250 000
5	130 000	300 000
6	130 000	550 000

Required:

2.1.Calculate the net present value (NPV) of each project, assess its acceptability and indicate which project is best, using NPV.

2.2. Calculate the internal rate (IRR) of each project, assess its acceptability and indicate which project is best, using IRR.

2.3.Calculate the profitability index (PI) of each project, assess its acceptability, and indicate which project is best, using PI.

2.4.Draw the NPV profile project SQ and HT on the same set of axes and use this diagram to explain why the NPV and the IRR show differences for these two mutually exclusive projects. Discuss this difference in terms of both the “scale problem” and the “timing problem”.

2.5.Which of the two mutually exclusive projects would you recommend that JK Products undertake? Why?

Answer 1