Question 1

Hiram Finnegan Int. (HFI) is a high-tech company in designing computer software. Due to high market demand for its products, the company is going to expand its business by considering three projects. The three projects all have the same maturity of three years. The first project is called Alpha that needs an initial investment of 20 million. Alpha is able to generate a cash flow of 70 million at the end of the first year, the second cash flow of 10 million at the end of the second year, and the last cash flow of 10 million at the of the third year. The second project is called Beta that needs an initial investment of 10 million. Beta is forecasted to have a cash flow of 15 million at the end of the first year, the second cash flow of 40 million at the end of the second year, and the final cash flow of 10 million at the end of the third year. The third project is called Gamma that needs an initial investment of 10 million now and a further investment of 5 million at the end of the first year. Gamma will have a cash flow of 60 million at the end of the second year and the final cash flow of 10 million at the end of the third year. Assume the annual discount rate is 12%.

(i) Calculate net present values (NPV) and the profitability index (PI) for Alpha, Beta and Gamma. Assume that the three projects are independent of each other, which project(s) should be accepted in terms of NPV and PI (10 marks)?

(ii) Calculate payback periods for Alpha and Beta. Consider Alpha and Beta. If these two projects are mutually exclusive -i.e. HFI can only accept either Alpha or Beta, should you use NPV or payback method to evaluate the two projects and what are the differences between the two methods? (8 marks)

(iii) Assume that HFI only has a 20 million budget, which project(s) should HFI invest in? Please justify your answer. (7 marks)