Question

The company estimates that its cost of capital is 15%. It is considering whether to invest in Shining Zambian, which has the following cash flows and will make the decision on the basis of the Net present value of the project: Estimated Cash Flows of the Project of Shining Zambian Limited Year Cash flows in (K’ Millions) 0 (100,000) 1 50,000 2 30,000 3 70,000 4 20,000   Note: Zambians abroad investments hopes to recoup its investment and payback any amounts owed to external stakeholders within 3 years, Equipment and Machinery owned by Shining Zambian is deemed to have zero residual value, life span of this Machinery and Equipment is 4 years, current value of this Machinery and Equipment is K850, 000 For each answer below explain and advice the economic implications for the Zambians abroad Investment group and the meaning of your answer based on the note above. a) Should the project be undertaken based on Net Present Value (NPV)? [10 Marks] b) Calculate the Payback Period (PBP) of the investment in months. [5 Marks] c) Calculate the Accounting Rate of Return (ARR) for this project. [5 Marks] d) Calculate the Internal Rate of Return (IRR) for the project. [5 Marks] e) As the Financial Manager of your Investment group (Zambians abroad Inv) the group has asked if it is possible to apply the Portfolio theory in diversifying their portfolio but lack the financial understanding of what this means, they have asked you to explain this theory and to advise them based on the information you have calculated above how this theory can be applied. and you have also been also asked to indicate the different levels of risk between high risk, low risk and Medium risk if the investment group invests in the following categories

For each of the following forms of Financial Instruments risk please indicate if they are: High risk, Medium risk or Low risk

Financial Instruments to Invest In

Annuities

Money Market deposit Accounts

Mutual Funds

CDS(Certificates of Deposit)

                                                                                                                       [5 Marks]

Answer 1

(a) Computation of Net Present Value of Shining Zambian

Year	Cash Flow	PVF@15%	Persent Value(k'Million)
0	(1,00,000)	1	(1,00,000)
1	50,000	0.8695	43,475
2	30,000	0.7561	22,683
3	70,000	0.6575	46,025
4	20,000	0.5717	11,434
		NPV	23,617

Decision:- Project should be undertaken due to positive NPV.

(b) Calculation of Payback Period

Year	Cash Flow	Net Invested Cash
0		-1,00,000
1	50,000	-50,000
2	30,000	-20,000
3	70,000	50,000
4	20,000	70,000

Table Indicate that Payback period is in between year 2 and year3.

if we calculate payback in months than:- Initial investment / cash flow pe year

= 1,00,000 / 42,500 = 2.35 year

= 29 months

(c) Computation of Accounting Rate of Return

Formula = Average Annual Profit / Average Investment

= (1,70,000/4) / 100000

= 42,500 / 1,00,000

= 42.5%