P. Muli was recently appointed to the post of investment manager of Masada Ltd. a quoted company. The company has raised Sh.8,000,000 through a rights issue.

P. Muli has the task of evaluating two mutually exclusive projects with unequal economic lives. Project X has 7 years and Project Y has 4 years of economic life. Both projects are expected to have zero salvage value. Their expected cash flows are as follows:

Project Year	X Cash flows (Sh.)	Y Cash flows (Sh.)
1 2 3 4 5 6 7	2,000,000 2,200,000 2,080,000 2,240,000 2,760,000 3,200,000 3,600,000	4,000,000 3,000,000 4,800,000 800,000 - - -

The amount raised would be used to finance either of the projects. The company expects to pay a dividend per share of Sh.6.50 in one years time. The current market price per share is Sh.50. Masada Ltd. expects the future earnings to grow by 7% per annum due to the undertaking of either of the projects. Masada Ltd. has no debt capital in its capital structure.

Required:

(a) The cost of equity of the firm. (3 marks)

(b) The net present value of each project. (6 marks)

(c) The Internal Rate of return (IRR) of the projects. (Rediscount cash flows at 24%

for project X and 25% for Project Y). (6 marks)

(d) Briefly comment on your results in (b) and (c) above. (2 marks)

(e) Identify and explain the circumstances under which the Net Present Value (NPV) and the Internal Rate of Return (IRR) methods could rank mutually exclusive projects in a conflicting way. (5 marks)

(Total: 22 marks)