Reference no: EM133058396
Dorset plc is considering three investment opportunities, which each has a duration of 4 years. The initial capital investment required, and the Net Present Value (NPV) are as follows:
Initial investment NPV
£m £m
Project 1 3.85 0.85
Project 2 4.25 0.90
Project 3 2.95 0.68
Only £7.5 m is available, and the directors intend to limit their capital expenditure to this amount and with no intention of borrowing, when considering the above projects. This means that the company may not be able to invest in all three projects.
Notes:
- The company has used its cost of capital of 14% to evaluate all three investments.
- Any surplus cash could be invested in the money market at 6%.
- Assume all rates in this part of the question are net of tax.
Requirement
a) Discuss and recommend, with reasons, which project(s) should be undertaken assuming
i) the projects are not divisible
ii) the projects are divisible
b) Dorset plc would like to consider applying the Internal Rate of return (IRR) to evaluate the three investment opportunities. Explain to the directors the implication of using the IRR on appraising the three projects
(Note: calculation of IRR for the three projects is not required for this question)
c) Discuss whether the decision of Dorset plc not to borrow, thereby limiting investment expenditure, is in the best interests of its shareholders
d) Advise Dorset plc on the use of sensitivity analysis to evaluate the riskiness of the projects.
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