Question
Abdulbaqi graduated from University of Bahrain, College of Business Administration in July and has been working for about a month as a Junior Financial Analyst
Abdulbaqi graduated from University of Bahrain, College of Business Administration in July and has been working for about a month as a Junior Financial Analyst at Aluminium Bahrain B.S.C. (#ALBA), one of the largest and most modern aluminium smelters in the world. When Abdulbaqi arrived at work on Thursday morning, he found the following memo in his e-mail:
To: Abdulbaqi Jalal Ali Abdulaal
From: Bryan Harris, Chief Financial Officer, ALBA
RE: Capital Budgeting Analysis
Provide an evaluation of two proposed projects whose cash flow forecasts are found below:
| Potline 7a | Potline 7b |
Initial Outlay | BHD (11,000,000) | BHD (16,950,000) |
Year 1 | 3,000,000 | 8,100,000 |
Year 2 | 3,000,000 | 2,900,000 |
Year 3 | 4,000,000 | 4,400,000 |
Year 4 | 0 | (1,400,000) |
Year 5 | 7,000,000 | 8,100,000 |
Year 6 | 7,000,000 | 8,100,000 |
Since these projects involve additions to ALBAs portfolio of high quality aluminium product line, the company requires a rate of return on both projects equal to 8,75%. As you are no doubt aware, ALBA relies on several criteria when evaluating new investment opportunities. In particular, we require that projects that are accepted have a payback of no more than 4 years, provide a positive NPV, and have an IRR that exceeds the companys discount rate.
Give me your thoughts on these two projects by 9am Sunday morning.
Abdulbaqi was not surprised by the memo, for he had been expecting something like this for some time. ALBA followed a practice of testing each new financial analyst with some type of project evaluation exercise after the new hire had been on the job for a few months.
After re-reading the memo, Abdulbaqi decided on his plan of attack. Specifically, he would first do the obligatory calculations of Payback, NPV, and IRR for both projects. Abdulbaqi knew that the CFO would grill him thoroughly on Sunday morning about his analysis, so he wanted to prepare well for the experience. One of the things that occurred to Abdulbaqi was that the memo did not indicate whether the two projects were independent or mutually exclusive. So, just to be safe, he thought he had better rank the two projects under all assumptions in case he was asked to do so on Sunday morning. Abdulbaqi sat down and made up the following "to do" list:
1. Compute Payback, NPV, and IRR for both projects.
2. Evaluate the two projects' acceptability using all three decision criteria (listed above) and based on the assumptions that the projects are both independent and mutually exclusive.
3. Rank the two projects according to Profitability Index and make a recommendation as to which (if either) should be accepted under the assumption that the projects are mutually exclusive.
4. What would you do if economic lives of the projects were unequal? Research, Explain and Make some suggestions based on the assumption that the projects are mutually exclusive. Also list the sources you have benefited such as
1) Richard Brealey. 2017. Principles of Corporate Finance, McGraw Hill, New York
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