A mining company is evaluating four 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. The shareholders of the company regard the company as relatively risky, given its existing portfolio of projects. Other company's shares in this risk class have given a return of 16 percent 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.

 

Ignore taxation and inflation.
3.1. The managing director has been on a one-day intensive course to learn about projectappraisal techniques. Unfortunately, during the one slot given over to NPV he had toleave the room to deal with a business crisis, and therefore does not understand it. Hevaguely understands IRR and insists that you use this to calculate which of the fourprojects should be proceeded with, if there are no limitations on the number which can
be undertaken.
3.2. State which is the best project if they are mutually exclusive (i.e., accepting oneexcludes the possibility of accepting another), using IRR. (3)
3.3. Use the NPV decision rule to rank the projects and explain why, under conditions ofmutual exclusivity, the selected project differs from that under (3.2. above) (4)
3.4. Draft a report for the managing director, detailing the value of the net present valuemethod for shareholder wealth enhancement and explaining why it may be consideredof greater use than IRR.

Project (Rands) A B C D to -5 266 -8 000 -2 100 -1 975 t1 2 500 0 200 1 600 Year t2 2 500 0 2 900 800 t3 2 500 10 000 0 0