Question
Capaldi plc has the following investment opportunities, none of which is divisible, i.e. each project must be undertaken in its entirety, or not at all,
Capaldi plc has the following investment opportunities, none of which is divisible, i.e. each project must be undertaken in its entirety, or not at all, it isnt possible to carry out a fraction of a project:
Project |
Profitability Index | Initial Investment 000 |
A | 1.42 | 700 |
B | 1.75 | 1,000 |
C | 1.75 | 800 |
D | 1.50 | 1,600 |
E | 1.90 | 900 |
Funding a portfolio of these projects would not require a change to the companys financial structure and each project has the same risk as the companys existing business. Each project has a conventional cash flow profile with a single initial investment outlay. Projects B and C are mutually exclusive. The company has investment funds that are limited to a total of 4m. Any surplus funds can be used to reduce the companys bank overdraft, on which interest is currently payable at 6% p.a.
Required:
a. Define the Internal Rate of Return (IRR) concept and explain how it may be used in project appraisal;
b. Explain what is meant by a conventional cash flow profile and explain its significance in relation to IRR;
c. Using a discount rate of 8%, identify the projects that should be selected to maximise net present value (NPV) and calculate the NPV figure that results from your selected portfolio of projects;
d. Again using a discount rate of 8%, identify the projects that should be selected to maximise NPV and calculate the NPV figure that results from your selected portfolio of projects if the projects were divisible, i.e. fractions of a project could be undertaken;
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