Question One:

1. Johnson Ltd is considering investment in a project with below details. Analyse this investment using only Economic Value-Added Method (EVA):

• It is a three-year project with initial investment of $12 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 $6.6 Million, $7.1 Million, and $8 Million, respectively with WACC 9% and tax rate 30%.
• Increases in net working capital investment each year is 20% 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)

1. Explain why the results of the projects analysis using EPS sometimes differ from the results from NPV analysis (1 mark)? In this case, which method results should be approved (NPV or EPS) (1 mark)? Why (1 mark)?

(3 marks)

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