Rand water is evaluating five possible projects to enhance the efficiency of its water treatment plant. It is permitted to spend $5million on investment projects at Time 0.
The cash flows for five proposed projects are:
Year Projects ($ million) -1.5 0.5 0.5 1.0 1.0 A B -2.0 0.0 0.0 0.0 4.0 C -1.8 0.0 0.0 1.2 1.2 D -3.0 1.2 1.2 1.2 1.2 E -0.5 0.3 0.3 0.3 0.3
Cost of capital is 12%, all projects are divisible and none may be repeated. The projects are not mutually exclusive.
1.1 Which projects should be undertaken to maximise NPV in the presence of the capital constraint? (10 Marks)
1.2 If the division was able to undertake all positive NPV projects, what level of NPV could be achieved? (5 marks)
1.3 If you now assume that these projects are indivisible, how would you allocate the available $5 million? (5 marks)
Rand water is evaluating five possible projects to enhance the efficiency of its water treatment plant. It is permitted to spend $5million on investment projects at Time 0.
The cash flows for five proposed projects are:
| Year | |||||
| Projects ($ million) | -1.5 | 0.5 | 0.5 | 1.0 | 1.0 |
| A | |||||
| B | -2.0 | 0.0 | 0.0 | 0.0 | 4.0 |
| C | -1.8 | 0.0 | 0.0 | 1.2 | 1.2 |
| D | -3.0 | 1.2 | 1.2 | 1.2 | 1.2 |
| E | -0.5 | 0.3 | 0.3 | 0.3 | 0.3 |
Cost of capital is 12%, all projects are divisible and none may be repeated. The projects are not mutually exclusive.
1.1 Which projects should be undertaken to maximise NPV in the presence of the capital constraint? (10 Marks)
1.2 If the division was able to undertake all positive NPV projects, what level of NPV could be achieved? (5 marks)
1.3 If you now assume that these projects are indivisible, how would you allocate the available $5 million? (5 marks)
Related questions
Jackson Resources is evaluating 4 major projects which have either two or three year lives. The company has raised all of its capital in the form of equity and has never borrowed money. This is partly due to the success of the business in generating income and partly due to an insistence by the dominant managing director that borrowing is to be avoided if at all possible. Shareholders in Jackson resources regard the company as relatively risky, given its existing portfolio of projects. Other company's share in this risk class have generally given a return of 16% per annum and this is taken as the opportunity cost of capital for the investment projects. The risk level for the proposed projects is the same as that of the existing range of activities.
| Years | ||||
| Projects (Dollars) | T0 | T1 | T2 | T3 |
| A | -5266 | 2500 | 2500 | 2500 |
| B | -8000 | 0 | 0 | 10000 |
| C | -2100 | 200 | 2900 | 0 |
| D | -1975 | 1600 | 800 | 0 |
Ignore taxation and inflation.
1.1 The managing diretor has been on a one-day intensive course to learn about project appraisal techniques. Unfortunately, during the one slot given over to NPV he had to leave the room to deal with a business crisis, and therefore does not understand it. He vaguely understands IRR and insists that you use this to calculate which of the 4 projects should be proceeded with, if there are no limitations on the number which can be undertaken. (10 marks)
1.2 Sate which is the best project if they are mutually exclusive (i.e accepting one excludes the possibility of accepting others) using IRR. (3 marks)
1.3 Use the NPV decision rule to rank the projects and explain why, under conditions of mutual exclusivity, the selected project differs from that under (1.2 above)... (4 marks)
1.4 Write a report for the managing director, detailing the value of the net present value method for shareholder wealth enhancement and explaining why it may be considered of greater use than IRR. (8 marks)
