QUESTION 5

(a)Roan Air is considering a project which has an up-front cost paid today at t = 0.

The project will generate positive cash flows of K60,000 a year for the next five years (the first cash flow occurs at the end of year 1). The project's NPV is K75,000 and the required rate of return is 10 percent. What is the project's payback period (assume cash flows are generated evenly through each year)?

(8 marks)

(b)A real estate developer wants to use a corner plot she owns, to either set up a gas station or construct an apartment building. The required rate of return is 10%. Using a four-year planning horizon, she does a comparative cash flow analysis of the two alternatives:

Year Gas Station Apartment building

0 - K100 - K100

1 50 20

2 40 40

3 40 50

4 30 60

Using the NPV criterion, select the project she should adopt.(17 marks)

(c)Your firm is considering investing in a project, the details of which are given below:

A new machine costing K10,000 is required.

The project also requires an initial net working capital of K1,000, which will be

recovered at the end of the project life (year 3)

The new machine is being depreciated using the straight-line method to a zero salvage value.

The new machine can be sold at the end of the project (end of year 3) for K5,000.

The project will generate earnings before depreciation, interest, and taxes

(EBDIT) of K4,000 in year 1, K5,000 in year 2 and K6,000 in year 3.

The firm's tax rate is 40%.

(a)What will be the initial investment in year 0?(3 marks)

(b)What are the post-tax operating cash flows in years 1 to 3? (9 marks)

(c)What is the non-operating cash flow in year 3?(3 marks)

(d)Use the AAR, NPV and PI methods to decide if the project should be undertaken or not. Use 10% as the discount rate where needed.(12 marks)

(Total: 29marks)