1. Investment Decision Under Certainty
Al Imam Mohammad Ibn Saud Islamic University
College of Economics and Administrative Sciences
Department of Finance and Investment
Level 4: All branches
EXERCISE 2
Investment Decision Under Certainty

2. Problem 1
Assuming that your firm is considering investment in a new project with the cash flows shown below, that the required rate of return on this project is 10%, and that the maximum allowable payback and discounted payback statistics for your company are 3 and 3.5 years, respectively.
Time 1 2 3 4 5
C F
-70000
15000
20000
40000
45000
50000

3. Questions
Use the payback decision rule to evaluate this project; should it be accepted or rejected? Justify your answer.
Use the DPB decision rule to evaluate this project; should it be accepted or rejected? ? Justify your answer.
Use the Net Present Value (NPV) decision rule to evaluate this project; should it be accepted or rejected?
Use the Profitability Index (PI) decision rule to evaluate this project; should it be accepted or rejected?
Use the IRR decision rule to evaluate this project; should it be accepted or rejected?
Use the MIRR decision rule to evaluate this project; should it be accepted or rejected?

4. Problem 2
Consider the following abbreviated financial statements for a proposed investment
Years  1 2 3
Sales 
400,000
600,000
800,000
Costs 
140,000
300,000
Depreciation 
Gross Profit
Taxes (20%) 
Net Income 

5. Questions:
If the total investment cost of this project is 600,000 Saudi Riyals, what is the average accounting return (ARR) for the proposed investment?
Calculate the (NPV), (IRR) and the (PI) for this investment?
(the required rate of return on projects of this risk class is 8%).

6. Problem 3
ALHILAL Inc. is considering two mutually exclusive projects with widely differing lives. The company's cost of capital is 14%. The project cash flows are summarized as follows:
Cash flows
Project A
Project B
CF0
-30,000
-28,000
CF1
17,500
8,200
CF2
CF3
CF4
CF5
CF6
CF7
CF8
CF9

7. Questions 1- Compare the two projects by using NPV.
2- Compare the projects by using the replacement chain approach.
3- Compare the projects by using the EAA method.
4- Chose a project and justify your choice.