Based on management’s recommendation, £1,320,00 has been allocated to execute some of the projects. These projects are labeled 1-8. The projects are not mutually exclusive. The table below provides you with the cost of each project, duration of each project and expected cash inflows at the end of each year. All the cashflows are in annuity. The estimated cost of capital is 10%.
Project Cost (in £) Project duration (in years) Annual cash inflow (in £)
1 (800,000) 20 117,200
2 (200,000) 8 48,000
3 (100,000) 5 28,000
4 (170,000) 15 24,000
5 (5200,000) 10 110,000
6 (150,000) 6 36,000
7 (500,000) 10 82,000
8 (500,000) 3 202,000
AZAR plc. has sought your advice as to which of the above projects should it select to invest the £1,320,000. The projects are divisible.
Required
1) Calculate the Net Present Value (NPV) for each project.
State the NPV decision rule
Based on the NPV decision rule, select the projects that should be financed with the £1,320,000 budget
Calculate the overall NPV for the selected projects in part b)
(Total: 25 marks)
2) Calculate the Profitability Index (PI) for each project
Use the calculation in part 2) to rank the projects from the most preferred to the least preferred
Explain the PI decision rule
Based on the PI decision rule select which of the projects should be financed with the £1,320,000 budget
Calculate the overall NPV for the selected projects in part c)
(Total: 25 marks)
3) Calculate the Internal rate of return of (i) Project 1, which has an initial cost of £800,000 and an annual cash inflow of £117,200 for 20 years; and (ii) Project 2, which has an initial cost of £200,000 and an annual cash inflow of £48,000 for 8 years. All the cashflows are in annuity.
Given that AZAR plc. operates a 14% minimum required rate of return policy, based on your IRR analysis, advice on which of the projects should be accepted or rejected.
(Total: 25 marks)
4) Comment on the importance of investment appraisal and explain the advantages and disadvantages for each of the following investment appraisal techniques
Net Present Value
Internal rate of return
Profitability index
Modified internal rate of return
