QUESTION ONE The Zeda Company Ltd. is considering a substantial investment in a new production process. From a variety of sources, the total cost of the project has been estimated at Sh.20 million. However, if the investment were to be increased to Sh.30 million, the productive capacity of the plant could be substantially increased. Due to the nature of the process, it would be exorbitantly expensive to increase capacity once the equipment is installed. Once of the problems facing the company is that there is a considerable degree of uncertainty regarding demand for the product. After some research which has been conducted jointly by the marketing and finance departments, some data has been produced. These are shown below: Investment A (Sh.20 m) 43 Year Demand Probability Investment B (Sh.30m) Annual Net Cash Flow Demand Probability Annual Net Sh.(million) Cash Flow Sh.(million) 1. 1-4 0.4 6 0.3 10 5-10 0.4 5 7 2 1-4 0.4 6 0.5 8 5-10 2 4 3. 1-10 0.2 2 0.2 1 Cost of capital for the firm is 10%. REQUIRED: (a) Prepare a statement which clearly indicates the financial implications of each of the two alternative investment scenarios. (12 marks) (10 marks) (Total: 22 marks) (b) Comment on other matters which the management should take into account before reaching the final decision. PVIFA: 10% 5 years = 3.79 PVIFA: 10% 10 years 6.14 PVIFA: 10% 10 years = 0.62 QUESTION TWO (b) 32 Explain the concept of "rate of interest" in the context of financial decisions. (5 marks) The Mentala Plastics Company has been dumping in the local council waste collection centre some 30,000 Kg. of unusable chemicals each year. In addition to being an eyesore, the residents of a nearby estate have started complaining of bad odour emanating from the dump and suspect that the company is to blame. The company has received information that these chemicals can be recycled at relatively little cost. The equipment to do it is however rather expensive and, in addition, the chemicals recovered are of a relatively poor quality. Investigations have shown that these chemicals can be sold to another firm at an average price of Sh.35 per Kg. The direct cost of recycling has been calcultated at Sh.15 per Kg. but this is before depreciation and taxes. The equipment for this process has an expected life of 10 years and a current cost of Sh.2 million. At the end of the ten years, it will be virtually worthless. For financial analysis, the company uses the straight line method of depreciation and an average tax rate of 40%. It has a required rate of return of 15%. REQUIRED: Compute the project's net present value (N.P.V). i 11. Compute the payback period and the accounting rate of return. Compute the internal rate of return (IRR). iv. Should this project be undertaken? Explain. Are there any other important matters that the company should consider in evaluating this project?