Question

QUESTION 1 [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 is 12%.
The following information is available:

		Net cash flows
	Project A	Project B
	N$000	N$000
Initial Investment	46000	46000
Year 1	17000	15000
Year 2	14000	13000
Year 3	24000	15000
Year 4	9000	25000
Estimated scrap value at the end of year 4	4000	4000

Depreciation is charged on the straight line basis.

1. 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 N$80 000 000 available to invest.

2. Explain three non-financial considerations that should be taken into account before a project is chosen

Answer 1

Step 1: Since, Organisation is having 2 projects and organisation can accept only one project due to lack of fund available, Organisation should accept that project, which result in higher NPV.

		Net Cash Flows
		Project A			Project B
Particulars	Year	N$000	PVF@12%	PV of Cash Flow	N$000	PVF@12%	PV of Cash Flow
Initial O/F	0	46000	1	-46000	46000	1	-46000
Inflow	1	17000	0.892857	15178.57	15000	0.892857	13392.85714
Inflow	2	14000	0.797194	11160.71	13000	0.797194	10363.52041
Inflow	3	24000	0.71178	17082.73	15000	0.71178	10676.70372
Inflow	4	9000	0.635518	5719.663	25000	0.635518	15887.95196
Scrap	4	4000	0.635518	2542.072	4000	0.635518	2542.072314
NET PRESENT VALUE (NPV) OF A				5683.747	NPV 'B'		6863.105542

Since, Project B is having NPV more than Project A, Organisation should go for Project B.

Step 2: ( Answer 1) Since, Organisation is undertaking both project, but due to insufficiency of fund, organisation should undertake Project B (in full) due to its high NPV ( at same amount of initial investment) and Project A ( in part)

So, NPV would be:

Project B NPV + Project A NPV in part

i.e. 6863.11+ 5683.75*(( 80000-46000)/46000)

i.e. 6863.11+4201.03

= 11064.1 Ans.

Step 3: Non Financial Considerations:

1. Feasibility Study: whether the feasibility study is carried out, and project is feasible in all respect including technical, economical, financial, legal etc.

2. Reputation/ Goodwill: whether the aforementioned projects would add on the reputation or morale in the mind of the investor and general public? sometimes +ve NPV projects are also not considered good and viable as they may result in negative goodwill to the organisation.

3. Ease of Maintenance: whether the project is able to be maintened by the organisation? if not, project should not be started.