Reference no: EM132678423

PEI is a privately-owned college of higher education in Canada. It competes directly with other private and government- funded Institutions. The college directors are considering two investment opportunities that would allow the college to expand in Canada (known as Projects A and B) and a third opportunity to set up a satellite training Centre in a foreign country (known as Project C). Ideally, it would invest in all three projects but the company has only CAD $25 million of cash available. PEI currently has borrowings of CAD $50 million and does not wish to increase indebtedness at the present time. PEI's shares are not listed. The initial capital investment required (on 1 January 2020) and likely net operating cash inflows arising from the investments in each project are as follows.

                            Initial Investment CAD $               Net Operating Cash inflows (after tax)

Project A              15.50 CAD                                   $1.75 million each year from year 1 indefinitely.
Project B              10.20 CAD                                   $1.15 million in year 1, and Rs. 3.10 million a year in years 2 to 7.
Project C               9.50 A                                        $ 210,000 each year for years 1 to 5.
Notes:

• The projects are divisible.
• Project B has a residual value of CAD $ 2.5 million. The other projects are expected to have no residual value. 
• Projects A and B are to be discounted at 8%. The Finance Director considers that a CAD $ discount rate of 9% is more appropriate for Project C as it carries slightly greater risk. 
• The CAD $ /A$ exchange rate is expected to be CAD $ /A$ 20.00 on 1 January 2020 (that is, A$ 1 = CAD $20.00). The CAD $ is expected to weaken against A$ by 1.5% per annum for the duration of the project.

Assume cash flows, other than the initial investment, occur at the end of each year.

Required:

Question (a) How to Calculate the NPV and PI of each of the THREE projects based on the CAD $ cash flows? Evaluate your results and advise PEI on how to allocate the limited funds to the projects.

Question (b) Explain the alternative method of evaluating Project C using an A$ discount rate, illustrating your answer with a calculation of an appropriate A$ discount rate.

Question (c) Discuss the key financial factors, other than the NPV decision, that should be considered before investing in a project located in a foreign country rather than the home country.