Question

1. Babadeni Ltd. is a highly geared company that wishes to expand its operations. Six possible capital investments have been identified, but the company only has access to a total of Sh.620,000,000. The projects are divisible and may not be postponed until a future period. After the project's end it is unlikely that similar investment opportunities will occur.

Expected net cash inflows (including salvage value)

Project	Year 1	Year 2	Year 3	Year 4	Year 5	Initial Oulay
	Sh. “000”	Sh. “000”	Sh. “000”	Sh. “000”	Sh. “000”	Sh. “000”
A	70,000	70,000	70,000	70,000	70,000	246,000
B	75,000	87,000	64,000	-	-	180,000
C	48,000	48,000	63,000	73,000		175,000
D	62,000	62,000	62,000	62,000		180,000
E	40,000	50,000	60,000	70,000	40,000	180,000
F	35,000	82,000	82,000			150,000

Projects A and E are mutually exclusive. All projects are believed to be of similar risk to the company's existing capital investments.

Babadeni Ltd. cost of capital is 12% a year.

Required

Using Profitabilty index criteria rank the projects and establish the optimal way of investing the available funds.

Answer 1

		Present Value(PV) of Cash Flow:
		(Cash Flow)/((1+i)^N)
		i=discount rate =Cost of Capital=12%=0.12
		N=Year   of Cash Flow
		CASH FLOW ANALYSIS OF PROJECTA
	IC	Initial Outlay	246,000
	N	Year	1	2	3	4	5
	CF	Cash Inflows	70,000	70,000	70,000	70,000	70,000	SUM
	PV=CF/(1.12^N)	Present Value of Cash Inflow	62,500	55,804	49,825	44,486	39,720	252,334
	SUM	Sum of PV of Cash Inflows	252,334
	PI=SUM/IC	Profitability Index=(Sum of PV of Cash Inflows)/(Initial Outlay)
	PI=SUM/IC	Profitability Index of Project A=	1.0257
		CASH FLOW ANALYSIS OF PROJECT B
	IC	Initial Outlay	180,000
	N	Year	1	2	3
	CF	Cash Inflows	75,000	87,000	64,000	SUM
	PV=CF/(1.12^N)	Present Value of Cash Inflow	66,964	69,356	45,554	181,874
	SUM	Sum of PV of Cash Inflows	181,874
	PI=SUM/IC	Profitability Index of Project B=	1.0104
		CASH FLOW ANALYSIS OF PROJECT C
	IC	Initial Outlay	175,000
	N	Year	1	2	3	4
	CF	Cash Inflows	48,000	48,000	63,000	73,000	SUM
	PV=CF/(1.12^N)	Present Value of Cash Inflow	42,857	38,265	44,842	46,393	172,357
	SUM	Sum of PV of Cash Inflows	172,357
	PI=SUM/IC	Profitability Index of Project C=	0.9849
		CASH FLOW ANALYSIS OF PROJECT D
	IC	Initial Outlay	180,000
	N	Year	1	2	3	4
	CF	Cash Inflows	62,000	62,000	62,000	62,000	SUM
	PV=CF/(1.12^N)	Present Value of Cash Inflow	55,357	49,426	44,130	39,402	188,316
	SUM	Sum of PV of Cash Inflows	188,316
	PI=SUM/IC	Profitability Index of Project D=	1.0462
		CASH FLOW ANALYSIS OF PROJECT E
	IC	Initial Outlay	180,000
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