QUESTION ONE KAP international plc is a quoted firm which operates ten Gold and land mines in Flouspar, Kenya. It has total assets of 50 million pounds and the value of its shares is 90 million pound. KAP international plc's directors perceive a great opportunity in the recent government's privatization drive and creation of ministry of mining. They have held preliminary discussions with the government about the purchase of the 25 mines. The purchase price suggested by the treasury is 900 million pounds equivalent. For two months the directors have been engaged in a fund-raising campaign to persuade shareholders and Jamii financial institutions to provide 500 million pounds of new equity capital of KAP international and 400 million pounds of fixed interest rate debt capital in the form of bank loans. Assume that you are a senior analyst with the fund management arm of A & sons index fund and last week you listened attentively to KAP international's presentation. You were impressed by their determination and track record but have some concerns about their figures for the new project. KAP international's projections are as follows, excluding the costs of purchasing the mines.

Table 1: Cash flows for the English lignite mines: KAP international's estimate.

time (t)	0	1	2	3	4	5and all the subsequent years
Sales (M Pounds) (cash inflows)		1200	1250	1300	1320	1350
Less operating costs (M pounds)(cash outflows)		1070	1105	1150	1190	1200
Net cash flows (M pounds) 130 145 150 130 150		130	145	150	130	150

You believe the probability of KAP international's projections being correct to be 50 per cent (or 0.5). You also estimate that there is a chance that KAP international's estimates are over-cautious. There is a 30 per cent probability of the cash flows being as shown in Table 2 (excluding the cost of purchasing the mines).

Table 2: A more optimistic forecast Time (t) 0 1 2 3 4 5 and all the subsequent years Sales (m Pounds) (cash inflows) 1,360 1,416.7 1,473.33 1,496 1,530 Less operating costs (m pounds)(cash outflows) 1,100 1140 1190 1225 1250 Net cash flows (m pounds) 260 276.7 283.33 271 280 On the other hand, events may not turn out as well as KAP international's estimates. There is a 20 per cent probability that the cash flows will be as shown in Table 3.

Table 3: A more pessimistic scenario (excluding purchase cost of mines). Time t 0 1 2 3 4 5 and all the subsequent years Sales (m Pounds) (cash inflows) 1,166.67 1,216.7 1,266.67 1,144 1,170 Less operating costs (m pounds)(cash outflows) 1,070 1105 1150 1165 1150 Net cash flows (m pounds) 96.67 111.7 116.67 -21 20

Furthermore, assume that the cost of capital can be taken to be 14 per cent and that Cash flows willarise at year end except the initial payments to the government which occurs at Time 0.

Required a) Calculate the expected value (NPV) and the standard deviation of the NPV for the project to buy the mines if 900m pounds are taken to be the initial cash outflow. b) There is a chance that events will turn out to be much worse than KAP international would like. If the net present value of the operation turns out to be worse than negative 550m pounds, KAP international will be liquidated. What is the probability of avoiding liquidation?

c) If the NPV is greater than positive 100m pounds then the share price of KAP international will start to rise rapidly in two or three years after the purchase. What is the probability of this occurring?

d) Besides the proposal presented above on purchasing mines, assume that the capital budgeting committee of KAP international has come with other project proposals for consideration. The consideration is on two mutually exclusive investments whose expected net cash flows are as follows; they also have an option to postpone the implementation of the project, based on the outcome of the discussions with the Government of Kenya.

Expected Net Cash Flows

years	project x$	project y$
0	-300	-405
1	-387	134
2	-193	134
3	-100	134
4	600	134
5	600	134
6	850	134
7	-180	0

For the above scenario, i. Construct NPV profiles for project A and B ii. What is each project's IRR iii. If you were told that each project's cost of capital was 10%, which project should be selected? If the cost was 17%, what would have been the proper choice? iv. What is the project's MIRR at a cost of 10 percent? At 17 percent v. What is the cross over rate and what is its significance