Question 1 – Capital Budgeting & Valuation

Arc Knight Ltd. is evaluating 5 independent projects, A to E with a total budget of $1 million. The 5 projects involve investing in sustainable energy and technology in different geographical locations. The company’s weighted average cost of capital is 10% per annum, the maximum cut-off period for payback is 3 years, and the following end-of-the-year cash inflows are forecasted:

**Project E: For Group 1 to Group 5, name your Project E as E1 to E5 respectively. The cash inflow will change according to your group number. In the 5-year period, there will be four equal cash inflows of $200,000 for four years and $0 cash inflow for one of the years. The year which is the same as your group number will have no cash inflow.

Group 1: Cash inflows for Project E1 is shown in the above table.

Group 2: Cash inflows for Project E2 is $0 in Year 2 and $200,000 for Year 1, 3, 4 and 5.

Group 3: Cash inflows for Project E3 is $0 in Year 3 and $200,000 for Year 1, 2, 4 and 5.

Group 4: Cash inflows for Project E4 is $0 in Year 4 and $200,000 for Year 1, 2, 3 and 5.

Group 5: Cash inflows for Project E5 is $0 in Year 5 and $200,000 for Year 1, 2, 3 and 4.

a. Calculate the Payback Period, Net Present Value (NPV), Internal Rate of Return (IRR) and Profitability Index (PI) for each of the 5 projects. Express your answers up to 2 decimal places and where relevant, state the unit clearly in your answers (year, % or $).

b) Explain which project(s), if any, is/(are) rejected based on all the four evaluation criteria. Briefly explain why it is (or they are)

c) If Arc Knight ’s decision is solely based on maximising the total NPV, which project(s) will be selected within the budget constraint of $1 million?

Support your project selection(s) with the necessary calculations and finally, compute the effective profitability index based on the total NPV and total initial investment costs of the selected project(s) as a whole.