Question

There are a senior manager at Zambia Airways and have been authorized to spend up to K400,000 FOR THE PROJECTS. The three projects you are considering have the fillowing characterics;

Project	Details
Project A	Intial investment of K280,000 .Cash flow of K190,000 at year 1 and K 170,000 at yr 2. This is a plant expansion project
Project B	Intial investment of K390,000. Cash flow of K270,000 at year 1 and K 240,000 at year 2. this is a new product development project
Project C	Intial investment of K230,000. Cash flow of K160,000 at year 1 and K190,000 at year 2. this is a market expansion project

Assume the corporate discount rate is 10%, please offer your recommedations by ranking the projects, backed by your analysis using:

a) Net Present Value

b) Profitabilty Index

c) payback period

d) Chritique the flaws of each technique

Answer 1

			Rank
a]	NPV of Project A = -280000+190000/1.1+170000/1.1^2 =	$             33,223	3
	NPV of Project B = -390000+270000/1.1+240000/1.1^2 =	$             53,802	2
	NPV of Project C = -230000+160000/1.1+190000/1.1^2 =	$             72,479	1
	Ranking is done in the descending order of NPV, with Project C having the 1st
	rank.
b]	PI of Project A = (190000/1.1+170000/1.1^2)/280000 =	1.12	3
	PI of Project B = (270000/1.1+240000/1.1^2)/390000 =	1.14	2
	NPV of Project C = (160000/1.1+190000/1.1^2)/230000 =	1.32	1
	Ranking is done in the descending order of PI, with Project C having the 1st Rank.
		Years
c)	Payback period of Project A = 1+(280000-190000)/170000 =	1.53	3
	Payback period of Project B = 1+(390000-270000)/240000 =	1.50	2
	Payback period of Project C = 1+(230000-160000)/190000 =	1.37	1
	Ranking is to be done in the ascending order of PB, with Project C getting the 1st
	Rank.
	HENCE, Project C is recommended under all the three methods.
d]	Flaws of each technique:
	NPV:
	*Is an absolute measure. Does not relate the benefits to the initial investment
	in the form of a ratio. Hence, not suitable to assess the benefit per $ invested.
	*Not easy to understand for a layman
	*Difficult to calulate as discounting is to be used.
	*WACC is based on several assumptions wrt to cost of equity.
	PI:
	*Is a ratio. Does not give the absolute addition to net worth of shareholders.
	Hence, does not help to maximize NPV.
	*Not easy to understand for a layman
	*Difficult to calulate as discounting is to be used.
	*WACC is based on several assumptions wrt to cost of equity.
	Payback period:
	*Does not consider time value of money
	*Ignores cash flows beyong the payback period.