Invesco Ltd is contemplating investing in a project that requires an initial capital of sh.10,000,000. The project is expected to have a five-year economic life at the end of which it will have a salvage value of sh. 2,000,000. The company prefers a straight-line method of depreciation. Given below are the estimated cash flows expected from the project during the five years of its economic life.

Year Cash flow

1. 2,000,000

2. 2,500,000

3. 3,500,000

4. 4,000,000

5. 3,500,000

The cost of capital is 12%

Additional information

1. The management required a minimum payback period for any acceptable project is 3 years.

2. For any project to be accepted by the management required a return on investment of not less than 20%

Required:

Evaluate the projects viability using the following project appraisal techniques.

i) Payback Period (3 marks)

ii) Return on Investment (4 marks)

iii) Net Present Value (5 marks)

iv) Profitability Index (2 marks)

v) Internal Rate of Return (6 marks)

Question Two

Mazao Ltd has five independent projects all of which are indivisible. The cost of capital is 15% and the initial capital and the Net present values of the projects are given as follows. Each of the projects have a five-year economic Life.

Shs. Millions

Projects A B C D E

Initial capital 87.5 100 162.5 120 57.5

PV@15% 131.25 156.25 257.5 198.75 80

NPV 43.75 56.25 95 78.75 22.5

Additional information

Any surplus funds can be invested at a 20% rate of external investment per annum for the five years.

The capital available is only 250 million.

Required:

a) Determine the amount of capital limitation (2 marks)

b) Identify the possible combination of the projects and show the surplus capital if any. (4 marks)

c) Calculate the net present values that will be derived from the possible project combinations identified in (b) above (12 marks)

d) Which combination would you recommend and why? (2 marks)