Business and Law

    Kilkennie plc., manufactures components for the automobile industry. The company has recently been approached to supply components to eight projects. The finance manager, Fredrick Wright, is concerned that the existing funds available to the company are insufficient to execute all the projects. Based on Fredrick’s recommendation, management have decided to allocate £660,000 to execute some of the projects. These projects are labeled A-H. 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 £) A 400,000 20 58,600 B 100,000 8 24,000 C 50,000 5 14,000 D 85,000 15 12,000 E 260,000 10 55,000 F 75,000 6 18,000 G 250,000 10 41,000 H 250,000 3 101,000 Kilkennie plc has sought your advice as to which of the above projects should it select to invest the £660,000. The projects are divisible. Required 1) Calculate the Net Present Value (NPV) for each project a) State the NPV decision rule b) Based on the NPV decision rule, select the projects that should be financed with the £660,000 budget c) Calculate the overall NPV for the selected projects in part b) (Total: 25 marks) 2) Calculate the Profitability Index (PI) for each project a) Use the calculation in part 2) to rank the projects from the most preferred to the least preferred b) Explain the PI decision rule c) Based on the PI decision rule select which of the projects should be financed with the £660,000 budget d) Calculate the overall NPV for the selected projects in part c) (Total: 25 marks) 3) Calculate the Internal rate of return of (i) Project A, which has an initial cost of £400,000 and an annual cash inflow of £58,600 for 20 years; and (ii) Project B, which has an initial cost of £100,000 and an annual cash inflow of £24,000 for 8 years. All the cashflows are in annuity. Given that Kilkennie 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 I. Net Present Value II. Internal rate of return III. Profitability index IV. Modified internal rate of return (Total: 25 marks) FORMULAE SHEET FV = PV(1 + i) n 𝑃𝑉𝐴𝐹 = 1 𝑖 (1 − 1 (1 + 𝑖) 𝑛 ) 𝐹𝑉𝐴𝐹 = 1 𝑖 ((1 + 𝑖) 𝑛 − 1) 𝐼𝑅𝑅 = 𝑎 + (𝑏 − 𝑎) ( 𝑁𝑃𝑉𝑎 𝑁𝑃𝑉𝑎 − 𝑁𝑃𝑉𝑏 ) 𝑀𝐼𝑅𝑅 = √ 𝑇𝑉 𝑃𝑉 𝑛 − 1 𝐸𝐴𝐴 = 𝑁𝑃𝑉 𝑃𝑉𝐴𝐹 𝑃𝐼 = 𝐺𝑃𝑉 𝐶0 𝐸(𝑥) = ∑𝑥. 𝑝(𝑥) 𝜎𝑥 2 = ∑(𝑥 − 𝐸(𝑥)) 2 . 𝑝(𝑥) 𝜎𝑥 = √𝜎𝑥 2 𝐶𝑜𝑉 = 𝜎𝑥 𝐸(𝑥) 𝑃0 = 𝑑 𝑘𝑒 𝑜𝑟 𝑑0(1 + 𝑔) 𝑘𝑒 − 𝑔 𝑔 = 𝑟𝑏 𝑜𝑟 √ 𝑑0 𝑑−𝑛 𝑛 − 1 𝑘𝑒 = 𝑟𝑓 + 𝛽(𝑟𝑚 − 𝑟𝑓) 𝑊𝐴𝐶𝐶 = 𝑘𝑒 ( 𝑉𝑒 𝑉𝑒 + 𝑉𝑑 ) + 𝑘𝑑𝑎𝑡 ( 𝑉𝑑 𝑉𝑒 + 𝑉𝑑