Banden Ltd is a highly geared 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 projects end it is unlikely that similar investment opportunities will occur:

Projects 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 percent per year. The money market may be assumed to be an efficient market. Banden?s cost of capital is 12 percent per year.

Required:

(a) Calculate:

(i) The expected net present value.

(ii) The expected profitability index associated with each of the six projects, and rank the projects according to both of these investment appraisal methods. Explain brifely why these rankings differ.

(b) Give reasoned advice to Banden Ltd recommending which projects should be selected.

(c) 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.

(d) The director has also suggested the use of linear or integer programming to assist with the selection of projects. Discuss the advantages and disadvantages of these mathematical programming methods to Banden Ltd.

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Expected net cash inflows (including salvage value) Initial outlay Year 1 3 4 (£) (£) (£) (£) Project (£) (£) 70000 70000 70000 70000 70000 246 000 A B 75000 87000 64000 180 000 48 000 48000 63000 73000 175000 62 000 62000 62000 62000 D 180 000 40 000 50000 60000 70000 40000 180 000 35000 82000 82000 150 000