Question

Question1 [41 MARKS]

ABC Holdings is considering two projects. The projects are similar in nature and are expected to both operate for four years. Due to unavailability of funds to undertake both of them, only one project can be accepted. The cost of capital is12%.

The following information is available:

                                                                                                                           Net cash flows

                                                                                                                      Project A                       Project B

                                                                                                                           $                                   $

Initial investment                                                                                               46 000 000                     46 000 000

Year 1                                                                                                              17 000 000                     15 000 000

Year 2                                                                                                               14 000 000                     13 000 000

Year 3                                                                                                                24 000 000                     15 000 000

Year 4                                                                                                                  9 000 000                      25 000 000

Estimated scrap value at the end of year 4                                                               4 000 000                        4 000 000

Depreciation is charged on the strait line basis.

Requirements		subtotal	Total
a)	Calculate the following for both proposals
	i) The payback period( round off your answer to one decimal place)	2	2
	ii) The net present value(NPV)	4	6
	iii) The return on investment (ROI)	8	14
	iv) The residual income (RI)	4	18
	v) If the two projects are mutually exclusive, which project should be chosen and why?	4	22
b)	Determine the sensitivity of projects A to a change in cost of capital	6	28
c)	Determine the sensitivity of project B to a change in initial investment	2	30
d)	Assuming that the management of ABC holdings have decided to undertake both projects and the projects can be undertaken in part, how much NPV will they get if they have $80 000 000 available to invest.	5	35
e)	Explain three non-financial considerations that should be taken into account before a project is chosen	6	41

Answer 1

a..
Year	PrA. C/f	CumulativeP/B	PrB. C/f
0	-46000000	-46000000	-46000000	-46000000
1	17000000	-29000000	15000000	-31000000
2	14000000	-15000000	13000000	-18000000
3	24000000	9000000	15000000	-3000000
4	13000000	22000000	29000000	26000000
	22000000		26000000
	i.P/B period	2+(15/24)=		3+(3/29)=
		2.6		3.1
		Yrs.		Yrs.
	ii.NPV at 12%	5683747		6863106
	iii.ROI=NPV/Initial Investment
		12%		15%
	iv.Residual Income=NPV-(Initial investment*Cost of capital)
		163747		1343106
	v. Project B for its greater NPV, ROI & Residual income

b.Sensitivity of Project A's NPV to change in COC(+/-2%)
Year	PrA. C/f
0	-46000000
1	17000000
2	14000000
3	24000000
4	13000000
	22000000
		NPV10%-NPV12%)/NPV12%
ii.NPV at 12%	5683747	Change %
NPV at 10%	7935524	39.62%
NPV at 14%	3581186	-36.99%

c.Sensitivity of Project B's NPV to change in Initai Investment(+/-10%)
PrB. C/f	10%	-10%
-46000000	-50600000	-41400000
15000000	15000000	15000000
13000000	13000000	13000000
15000000	15000000	15000000
29000000	29000000	29000000
26000000	21400000	30600000
6863106	2263106	11463106
Change	-4600000	4600000
Change %	-67.03%	67.03%

d..Year	PrA. C/f	PrB. C/f
0	-40000000	-40000000
1	17000000	15000000
2	14000000	13000000
3	24000000	15000000
4	13000000	29000000
	28000000	32000000
ii.NPV at 12%	11683747	12863106

e.Three non-financial considerations that should be taken into account before a project is chosen

Possibility of Continuity in cash flows, considering political , environmentsl & other factors.

Existing employees' acceptance & comfort level in working with the new investment.

Any factor that will affect the existing relationship with customers & suppliers.