Osiadan Limited is a local real estate company that wishes to expand its operations. Six possible capital investments have been identified, but the company only has access to a total of $620,000. The projects are not 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 Outlay $ A 80,000 80,000 80,000 80,000 80,000 246,000 B 80,000 97,000 74,000 180,000 C 68,000 68,000 83,000 83,000 175,000 D 72,000 72,000 72,000 72,000 180,000 E 50,000 50,000 50,000 80,000 40,000 180,000 F 45,000 92,000 92,000 150,000 Project A and E are mutually exclusive. All projects are believed to be of similar risk to the company’s existing capital investments. Any surplus funds may be invested in the money market to earn a return of 9% per year. The money market may be assumed to be an efficient market. Osiadan Limited has the following information in its statement of financial position; $’000 Ordinary shares of $0.5 2,500 12% unsecured bonds 1000 The ordinary shares are currently quoted at $1.3 each and the bonds are trading at $72 per $100 nominal. The ordinary dividend of $0.15 has just been paid with an expected growth rate of 10%. Corporation tax is currently 30%. Required Calculate the expected net present value for each of the six projects. Calculate the expected profitability index associated with each of the six projects. Rank the projects according to both of these investment appraisal methods. Explain briefly why these rankings differ.
Osiadan Limited is a local real estate company that wishes to expand its operations. Six possible capital investments have been identified, but the company only has access to a total of $620,000. The projects are not 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
|
Project |
Year 1 $ |
Year 2 $ |
Year 3 $ |
Year 4 $ |
Year 5 $ |
Initial Outlay $ |
|
A |
80,000 |
80,000 |
80,000 |
80,000 |
80,000 |
246,000 |
|
B |
80,000 |
97,000 |
74,000 |
|
|
180,000 |
|
C |
68,000 |
68,000 |
83,000 |
83,000 |
|
175,000 |
|
D |
72,000 |
72,000 |
72,000 |
72,000 |
|
180,000 |
|
E |
50,000 |
50,000 |
50,000 |
80,000 |
40,000 |
180,000 |
|
F |
45,000 |
92,000 |
92,000 |
|
|
150,000 |
Project A and E are mutually exclusive. All projects are believed to be of similar risk to the company’s existing capital investments.
Any surplus funds may be invested in the
Osiadan Limited has the following information in its statement of financial position;
$’000
Ordinary shares of $0.5 2,500
12% unsecured bonds 1000
The ordinary shares are currently quoted at $1.3 each and the bonds are trading at $72 per $100 nominal. The ordinary dividend of $0.15 has just been paid with an expected growth rate of 10%. Corporation tax is currently 30%.
Required
- Calculate the expected
net present value for each of the six projects. - Calculate the expected profitability index associated with each of the six projects.
- Rank the projects according to both of these investment appraisal methods. Explain briefly why these rankings differ.
- Give reasoned advice to Osiadan Limited recommending which project should be selected.
- A director of the company has suggested that using the company’s normal cost of capital might not be appropriate in a capital rationing situation. Explain whether you agree with the director.
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