Notes

i$.$ The projects are not divisible

ii$.$ Each project can only be undertaken once

iii. Ignore tax

Required

$($a$)$ Advise $R$&$T$ on the best combination of projects based on an evaluation of each project

on the basis of both:

i$.$ NPV of cash flows;

ii$.$ A profitability index for use in this capital rationing analysis.

$($b$)$ Discuss

i$.$ Whether or not capital rationing techniques based on NPV analysis are appropriate for a

publicly$-$ owned entity such as R & T$.$

ii$.$ As a publicly$-$owned entity, what other factors R & T should consider and what other

analysis it should undertake before making a final decision on which project$($s$)$ to accept. $[4]$QUESTION $4[25$ MARKS$]$

$R$ & $T$ is a publicly$-$owned and funded health organisation based in the Far East. It is reviewing a number of interesting possibilities for new development projects in the area and has narrowed down the choice to the five projects detailed below. $R$ & $T$ is aware that government budget restrictions may be tighter in a year's time and so does not want to commit to a capital budget of more than $$30$ million in year $1.$ In addition, any project cash inflows in year $1$ may be used to fund capital expenditure in that year. There is sufficient capital budget remaining in year $0$ to enable all projects to be undertaken. Under government funding rules, any unused capital in year $0$ cannot be carried over to year $1$ and no interest may be earned on unused capital. No borrowings are permitted.

$R$&$T$ assesses capital projects at a hurdle rate of $15\%$ based on the equity beta of health based companies in the private sector.

$\backslash$table$[[,\backslash$table$[[$Cash$],[$outflows$]],$Cash inflows,Cash inflows,$],[,$Year $0,$Year $1,,],[$Project$,$$ million,$ million,$ million,$],[$A$,9,16,4,$from year $1$ in perpetuity$],[$B$,10,10,4,$from year $2$ in perpetuity$],[$C$,10,12,5,$in years $1$ to $10],[$D$,8,5,6,$in years $3$ to $7],[$E$,9,8,2,$in years $1$ to $5],[,,,5,$in years $6$ to $15]]$