Nkhosi PLC is a furniture manufacturer based in Zambia. It manufactures a limited range of furniture products to a very high quality and sells to a small number of retail outlets in the SADC region. At a recent meeting with one of its major customers, it became clear that the market is changing and the final consumer of Nkhosi PLCs products is now more interested in variety and choice rather than exclusivity and exceptional quality. Nkhosi PLC is therefore reviewing two mutually exclusive alternatives to apply to a selection of its products:

Alternative 1 To continue to manufacture, but expand its product range and reduce its quality. The net present value (NPV), internal rate of return (IRR), and modified internal rate of return (MIRR) for this alternative have already been calculated as follows: NPV: K1, 450,000 using a nominal discount rate of 9% IRR: 10.5% Payback: 2.6 years MIRR: 13.2% Discounted Payback: 3.05 years

Alternative 2 To import furniture carcasses in flat packs from South Africa. The imports would be in a variety of types of wood and unvarnished. Nkhosi PLC would buy in bulk from its South African suppliers, assemble and varnish the furniture and re-sell, mainly to existing customers. An initial investigation into potential sources of supply and costs of transportation has already been carried out by a consultancy entity at a cost of K75, 000. Nkhosi PLC's CFO has provided estimates of net Zambian Kwacha (ZMW) and South African Rand (ZAR) cash flows for this alternative. These net cash flows, in real terms, are shown below.

Year 0 1 2 3

ZAR (25,000,000) 2,600,000.00 3,800,000.00 4,100,000.00

ZMW 0 3,700,000.00 4,200,000.00 4,600,000.00

The following information is relevant: Nkhosi PLC evaluates all its investments using nominal kwacha cash flows and a nominal discount rate. All non-Zambia customers are invoiced in South African Rand, which is considered a vehicle currency in the SADC region. Rand nominal cash flows are converted to kwacha at the forward rate and discounted at the Zambian nominal rate. For evaluation, assume Nkhosi Limited has a three-year time horizon for investment appraisals. In addition, based on recent economic forecasts, inflation rates in South Africa are expected to be constant at 4% per annum while Zambian inflation rates are expected to be 3% per annum. The current exchange rate is S (ZMW/ZAR) =1.6. Consider taxation irrelevant. The CFO of Nkhosi PLC has approached you to seek advice on several issues.

Required:

a) Evaluate alternative 2, using net present value, discounted payback, internal rate of return, and the (approximate) modified internal rate of return. (14 marks) b) Calculate the project duration for alternative 2 and discuss the significance of your results if you are told that the duration for alternative one is 3.2 years. (4 marks) c) Evaluate the two alternatives and recommend which alternative the entity should choose. Include in your answer a discussion about what other criteria should be considered before a final decision is taken. (7 marks