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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

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