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The Rail project is one of the most exciting projects happening in Dubai where Sheikh Zayed road will witness some structural change
The Rail project is one of the most exciting projects happening in Dubai where Sheikh Zayed road will witness some structural change. Experts Ltd, one of the companies who won the construction contract, is now considering purchasing a land, next to Jebel Ali. The project will benefit from low loan rates and would require a minimum compound annual after-tax return of 10% in order to be acceptable. Experts Ltd initial Investment would be $5,000,000, the company expects to receive annual cash flows of $2,000,000 per year for the first two years, followed by $1,000,000 outlay in year 3, and $4,000,000 for the 2 last years, The maximum acceptable payback in the construction sector is currently 4 years. 1) 1) Based on the information provided, conduct an analysis and recommend if the project is going to add value to Experts Ltd. You should include the use of the following techniques. Show your workings and highlight your final answers.
Expert Solution
1)
i) Statement showing NPV
| Year | Cash flow | PVIF @ 10% | PV |
| A | B | C = A x B | |
| 1 | 2000000.00 | 0.9091 | 1818181.82 |
| 2 | 2000000.00 | 0.8264 | 1652892.56 |
| 3 | -1000000.00 | 0.7513 | -751314.80 |
| 4 | 4000000.00 | 0.6830 | 2732053.82 |
| 5 | 4000000.00 | 0.6209 | 2483685.29 |
| Sum of PV of cash inflow | 7935498.69 | ||
| Less: Initial Investment | 5000000.00 | ||
| NPV | 2935498.69 |
Thus NPV = $ 2935498.69
ii) Discounted payback period
Statement showing cummulative cash flow
| Year | Cash flow | PVIF @ 10% | PV | Cummulative cash flow |
| A | B | C = A x B | ||
| 1 | 2000000.00 | 0.9091 | 1818181.82 | 1818181.82 |
| 2 | 2000000.00 | 0.8264 | 1652892.56 | 3471074.38 |
| 3 | -1000000.00 | 0.7513 | -751314.80 | 2719759.58 |
| 4 | 4000000.00 | 0.6830 | 2732053.82 | 5451813.40 |
| 5 | 4000000.00 | 0.6209 | 2483685.29 | 7935498.69 |
Now using interpolation , we can find discounted payback period
| Year | Cummulative cash flow |
| 3 | 2719759.579 |
| 4 | 5451813.401 |
| 1 | 2732053.821 |
| ? | 2280240.421 |
= 2280240.421 / 2732053.821
= 0.83
Thus discounted payback period = 3 + 0.83 = 3.83 years
iii) Statement showing PI
| Year | Cash flow | PVIF @ 10% | PV |
| A | B | C = A x B | |
| 1 | 2000000.00 | 0.9091 | 1818181.82 |
| 2 | 2000000.00 | 0.8264 | 1652892.56 |
| 3 | -1000000.00 | 0.7513 | -751314.80 |
| 4 | 4000000.00 | 0.6830 | 2732053.82 |
| 5 | 4000000.00 | 0.6209 | 2483685.29 |
| Sum of PV of cash inflow | 7935498.69 | ||
| Less: Initial Investment | 5000000.00 | ||
| PI (Sum of PV of cash inflow / Initial Investment) | 1.59 |
Thus PI = 1.59
iv) MIRR = [FV of +VE cash flow / PV of -Ve cash flow]^1/n - 1
n = no of years = 5
Statement showing FV of +Ve cash flow
| Year | Cash flow | FVIF @ 10% | FV |
| A | B | A x B | |
| 1 | 2000000.00 | 1.4641 | 2928200 |
| 2 | 2000000.00 | 1.3310 | 2662000 |
| 3 | 1.1000 | 0 | |
| 4 | 4000000.00 | 1.1000 | 4400000 |
| 5 | 4000000.00 | 1.0000 | 4000000 |
| FV of +VE cash flow | 13990200 |
Statement showing PV of -Ve cash flow
| Year | Cash flow | PVIF @ 10% | PV |
| A | B | C = A x B | |
| 0 | 5000000 | 1 | 5000000 |
| 1 | 0.9091 | 0.00 | |
| 2 | 0.8264 | 0.00 | |
| 3 | 1000000.00 | 0.7513 | 751314.80 |
| 4 | 0.6830 | 0.00 | |
| 5 | 0.6209 | 0.00 | |
| PV of -VE cash flow | 5751314.80 |
Thus MIRR = [13990200/5751314.80]^1/5 - 1
= 2.4325^0.2 - 1
= 1.1946 - 1
= 0.1946
i.e 19.46%
2) Discounted payback method shouild be used while evaluating project because project has non conventional cash flow and hence there can be multiple IRR. Thus using IRR may gives us wrong signal and hence IRR should not be used
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