APITT Overview APIIT College of Higher Education (APITT) is a long-established, privately-owned college in country Jesco. The college competes with the public sector universities on a selected set of courses. The college functions under a commercial framework however it is registered as an education trust in order to avoid Jesco taxation. The new CEO has an idea to expand operations so that the college could offer all the courses offered by the public sector universities and to expand operations on a global basis. The CEO has consulted many experts to exercise his options overseas, however most of the faculty members prefer expansions in Jesco. The college cannot initiate both ideas simultaneously due to bottleneck resources. Expansion opportunities Two options are outlined below Option 1 Expansions in Jesco The level of facilities that are available in the present is not sufficient to accommodate the rise in student numbers as well as the courses planned to offer. Hence, APITT has found an ideal land area for the former purpose which is few miles away. APITT has already consulted the land owner and spoken to the local authorities regarding planning initiatives. The land areas identified has been already selected as an area of development by the Jesco government. Therefore APITT might receive financial incentives from the government for the former reason. However the land owner has informed that the approval would take six months. The most prominent limitation of this option would be that staff will have to travel between building locations since, the new building will not be able to accommodate all students and courses planned as a result of the expansion. However , on the contrary, the new building, might be highly lucrative for part time students as it is mentioned in the figures below. Many parties are looking forward to purchase this land area, hence APITT paid a non refundable deposit of $100,000 until the project appraisal is initiated. The land owner has informed APITT that it requires a decision within the next six months. Option 2 Expansions to a Middle Eastern Country Miraco APITT has been successful in getting admissions from full time students in Miraco and the faculty has taught a substantial number of course in Miraco. The CEO believes that the government of Miraco will support this investment decision. An ideal land area is available for APITT, to be purchased on a long term lease in 15 years time. There are break clauses within intervals of five years, where either party has the option to terminate the contract. However, if APITT terminated the contract , the college will not receive any refund or lease premium paid. Due to the prevailing situation the college wishes to recruit faculty from Miraco to teach in class and involve Jesco faculty for online teaching. The most prominent limitation of this option is the foreign exchange risk to APITTs finances. If fees are collected from Jesco $, this would adversely affect many students in Miraco. This is because in Miraco the US$ is used widely. Therefore, APITT has requested fees to be paid in US$. Furthermore, all expenses in the country of Miraco can be paid in US$ except for the capital costs. [AUTHOR NAME] 2 Cash flows for both options Capital costs Option 1 Option 2 Land cost Jesco $000 12,000 Miraco $000 15 years lease 40,000 Cost of building 6,000 20,000 Cost of equipment 2,000 10,000 The land is not subjected to depreciation. Cost of Buildings in option 1 will be depreciated based on the straight-line method for 20 years. The total capital costs of option 2 will be written off over the period of the lease. Replacements and refurbishments of equipment and buildings respectively will be required. However these costs have been excluded in the financial evaluation. Operating cash flows Option 1 Option 2 Jesco $000 US $000 Year 1 Year 2 Year 3 Year 1 Year 2 Year 3 Fees 3,500 4,500 5,400 9,300 10,700 12,900 Other information In option 1, fees and costs are forecasted to increase by 4% per annum from year 4 indefinitely. This is approximately the expected rate of inflation in Jesco. Current spot rates are Jesco $1 = Miraco $5.5 and Jesco $1 = US $2.1. Risk-free interest rates are currently 5% in Jesco and 6% in the US. These rates are likely to be maintained until year 3. In Miraco, there is no official interest rate and no forecast of inflation. APITT directors therefore assume, for convenience, that in option 2 the fees receivable in year 3 in Jesco $ terms will remain constant, in nominal terms, until year 15. Cash operating costs are assumed to be 65% of fees received each year in both options. Assume all capital costs are incurred in year 0 and all operating cash flows are received or incurred at the end of each year. A survey of the land in Jesco has been undertaken at a cost of Jesco $20,000. A report on the Miraco investment has been undertaken at a cost of Jesco $30,000. If option 1 is chosen, there will be an opportunity cost to the investment of faculty lost time in travelling between sites. This is estimated at 1.5% of fees each year. If the investment in Miraco goes ahead, fees on existing programmes in Jesco are likely to fall by Jesco $500,000 per annum for the duration of the investment. APITT has not made an investment on this scale before, but for the investment in Jesco (option 1) the directors believe, with justification, that 13% would be an adequate return to reflect the risks involved. A premium on the Jesco rate of +4% is considered appropriate for the investment in Miraco (option 2). Method of funding APITT has accumulated cash reserves of Jesco $6 million. The remaining capital costs will be funded by long-term borrowings. If option 1 is chosen, it will be funded by a 20 year commercial mortgage secured on the land and buildings. Interest will be fixed at 10% per annum, payable annually. APITT currently has no other long-term borrowings. [AUTHOR NAME] 3 If option 2 is chosen, it will be funded by one of the following methods: (i) A 15-year commercial loan taken out in Jesco $ at 11% per annum interest, capital repayable at the end of the term; (ii) A 15-year interest-free, non-repayable Miraco $ government loan, but for the duration of the loan the Miraco government would take a dividend each year equivalent to 21% of the profits earned in Miraco;

Required: (a) Calculate the net present value (NPV) in Jesco $ for the two alternative investments, using the cash flows and discount rates given in the scenario. (17 marks) (b) Assume you are the Financial Manager for APITT. Prepare a report to the Chief Executive evaluating the investment decision and its funding. Your report should include the following sections: (i) An evaluation of the two investments, including discussion of the key risk factors APITT should consider, the choice of discount rates used in the evaluation, and the real option features that are implied in the two investments. Discuss how these option features might impact on the investment decision being made. (14 marks) (ii) A discussion of the advantages and disadvantages of the methods of funding outlined in the scenario for option 2. Use appropriate calculations, where possible, to support your arguments. (11 marks) (iii) Recommendations about the choice of investment alternative and, if relevant, the method of funding. (5 marks) (Total for part (b) = 30 marks)