Question One:

• 1. Alpha Ltd is considering investment in a project with the below details. Analyse this investment using only the Economic Value-Added Method (EVA):
• It is a three-year project with initial investment of $15 Million, depreciating over three years using straight line method with zero salvage (residual) value at the end of year three.
• Estimated EBITDA for years 1-3 are $5 Million, $7 Million, and $8 Million, respectively with WACC 12% and tax rate 30%.
• Increases in net working capital investment each year is 25% of previous year end invested capital. Should Johnson invest in this project?

(2 marks for correct invested capital, 2 marks for correct NOPAT for all year, 1 mark for Discounting all EVAs and commenting on the investment decision)

5. Marks total)

1.2 Explain why the use of EVA fixes the equity cost problem with EPS accretive projects (with negative NPV), and also the back-loaded projects problem? (2 marks for discussion on each problem)

4. marks total)

1.3 Explain what the P/E ratio is (1 mark), how it is calculated (1 mark), and why firms with a high P/E ratio tend to choose bad projects with good earnings (underestimating their true cost of equity capital) (2 marks)?

(3 marks total)