FINANCIAL GOALS OF A FIRM

The main financial objective of financial management is to;

i. Maximize profits of the firm and

ii. Maximize shareholder wealth.
Maximization of profit ensures efficient allocation of resources by the firm and
also by society. The problem with this objective however includes;

i. Ignores risk – some investments may not be worth the risk.

ii. May require borrowing beyond the capacity of a firm to borrow.
iii.Ignores the timing of cost and returns – time value of money.
iv. Maximum profit is vague, is it short term or long term pretax profit as
often tax profit?
v. Profit motive is current or short term while benefits may accrue for many
years to come.
Therefore profit maximization is not operationally feasible.

Maximization of shareholder wealth

This means maximization of the value of a share of a firm. Shareholder wealth is

represented by the present value of all future cash flows in the form of dividends
and other benefits expected from the firm. Since each shareholder wealth at any
time is equal to the market value of all his holdings in shares, an increase in
market price of a firms shares should increase shareholder wealth. Consequently
financial decisions are made in such a way that shareholders receive the highest
combination of dividend and market price of a share. A firm also pursues non-
financial goals e.g. product quality, social responsibility etc.

Functions of a financial manager

a) Financing Decision
There are two main sources of finance for a firm equity and debt. The difference is
the fixed commitment created by borrowed funds in form of interest and principal
sum. A finance manager has to consider type, size and composition of capital
resources. Debt is cheap but entails some risk financial risk (nonpayment of
interest and capital amount. Equity on the other hand includes share capital,
revenue reserves and accumulated profits. The form of capital does not commit
outflow in form of return or repayment of capital.

Firms combine the two forms of capital in their operations. This combination is
known as financial leverage and each combination has its own implications
relating to the value of a firm.

b) Investment decision
Also called capital budgeting decision refers to allocation of funds among
investment projects. They refer to the firm’s decision to commit current funds to
the purchase of fixed assets in expectation of further cash inflows from the
projects. Investment proposals are evaluated in term of risk and expected returns,
overall investment decisions may include:-

i. Which asset to acquire out of different alternative option.

ii. To buy an asset or get it on lease.
iii. To produce part of the product or procure it from some other suppliers.
iv. To buy or not another firm as a running concern. (acquisition)

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 v. To merge with another for synergy from consolidation.
(Merger/combination)

The objective of capital budgeting decisions is to identify those assets that are
worth more than they cost.

c) Working capital decision

This deals with management of current assets and current liabilities of a firm. A
finance manager has to ensure sufficient and adequate working capital to the firm
for efficient operation. There is a tradeoff between profitability and liquidity. A
more liquid firm (with more cash) has lower risk of becoming insolvent. Decisions
here include how much cash, inventory to retain and how much credit to extend
to customers.

RISK AND RETURN TRADE OFF

Firms seek to strike a balance between risk and return involving financing and
investment so that shareholders wealth is maximized. Finance managers attempt
to find appropriate combination of investments, financing and dividend that adds
to values of a firm in the eyes of the public.

The Beta (β) statistic measures risk of a stock in the context of a well-diversified
portfolio. Investors consider good companies to be low risk and bad companies as
high risk. Fixed income instruments carry risk measured by duration (interest rate
sensitivity to a bond or note). The higher the sensitivity, the greater the volatility
of returns of the bond.

Risk can be defined as volatility of returns or percentage of returns that is

negative or below a given benchmark. Risk is measured by standard deviation.
The relationship between risk and return is direct (the higher the risk, the higher
the probability of return). When returns are constant across securities, the
rational investors choose that with lower risk and vice versa. Stock price
variability is caused by either market factors (economic, political or market
psychology) and or company specific factors like new discoveries, technology
or management. Risks related to market factors are systematic while the
remainder is non-systematic or equity specific). Unsystematic risk can be
diversified away but not systematic risk. Securities can be combined to form a
portfolio to reduce risk when especially their returns are negatively correlated.

Financial markets
Financial markets are the other important component of investment environment.
Financial markets are designed to allow corporations and governments to raise
new funds and to allow investors to execute their buying and selling orders. In
financial markets funds are channeled from those with the surplus, who buy
securities, to those, with shortage, who issue new securities or sell existing
securities. A financial market can be seen as a set of arrangements that allows
trading among its participants.
Financial market provides three important economic functions (Frank J.
Fabozzi, 1999):
1. Financial market determines the prices of assets traded through the
interactions between buyers and sellers;
2. Financial market provides a liquidity of the financial assets;
3. Financial market reduces the cost of transactions by reducing explicit costs,
such as money spent to advertise the desire to buy or to sell a financial asset.

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Financial markets could be classified on the bases of those characteristics:
• Sequence of transactions for selling and buying securities;
• Term of circulation of financial assets traded in the market;
• Economic nature of securities, traded in the market;
By sequence of transactions for selling and buying securities:
_ Primary market
_ Secondary market
All securities are first traded in the primary market, and the secondary market
provides liquidity for these securities.
Primary market is where corporate and government entities can raise capital
and where the first transactions with the new issued securities are performed. If a
company’s share is traded in the primary market for the first time this is referred
to as an initial public offering (IPO).
Investment banks play an important role in the primary market:
• Usually handle issues in the primary market;
• Among other things, act as underwriter of a new issue, guaranteeing the
proceeds to the issuer.
Secondary market - where previously issued securities are traded among
investors. Generally, individual investors do not have access to secondary
markets. They use security brokers to act as intermediaries for them. The broker
delivers an orders received form investors in securities to a market place, where
these orders are executed. Finally, clearing and settlement processes ensure that
both sides to these transactions honor their commitment.

TIME VALUE OF MONEY

Shareholders prefer to pay more for an investment that promises returns over a
shorter period than longer period. A shilling earned today is more valuable than a
shilling to be earned tomorrow. Cash inflow and outflows when investments are
undertaken occur at different times. Present cash outflows are followed by future
cash inflows at different times (periods) for a number of investments. Therefore in
order to compare the cash flows,, time and risk are incorporated in any valuation
model.

FUTURE VALUES

Compound interest and terminal values (future value)

Compound interest implies that interest paid on a loan or investment is added to

the principal so that subsequently interest is earned on interest.

Illustration compounding annually

A person with shs 100 in an account earning interest at a rate of 8% compounded

annually shall accumulate

TV = 100(1+0.08)1 = shs 108 at end of year 1

108 (1+0.08)1 = shs 116.64 at end of year 2

Or

100(1+0.08)2 = 116.64 and so on

Compounding more than once a year

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Suppose interest is paid semiannually and shs 100 is deposited in an account at 8
percent.

Terminal Value for the first 6 months becomes TV½ = 1001 + 0.08 1
= Shs 104

At the end of the year it becomes;

TV1 = 100(1+0.08)2 = Shs 108.16

Evidently more compounding in a year results in a higher terminal value.

General formula for solving terminal value at end of year and where interest is
paid m times a year.

TVn = Xo 1 + r n*m where m = number of times interest is paid in a

year, n = end of yr

m mn = number of periods

Quarterly compounding

If interest is paid quarterly in a year for a given (shs 100) investment, the terminal
value at the end of the year 1 would be;

TV1 = 100 (1+0.08)4×1 =shs 108.24

Which is higher than TV for investment with semi-annual compound interest

100(1+0.08)2×1 = shs 108.16

The greater the number of years, the greater the difference in terminal value
arrived at by using different methods of compound.

Infinite Compounding

As m approaches infinity, the term (1 +r) mn

approaches where e is approximately
2.718

e =lim (1 +1)m

m- ∞

The terminal value at the end of n years of an initial deposit of X o where interest is
compounded continuously at a rate of r is

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 TVn = X0 ern

For example shs 100 terminal value at end of 3 years with continuous compound
at 8% would become

TV3 = 100(2.718) (0.08) (3)

= Shs 127.12

Continuous compounding when compared with other finite compounding results

in the maximum possible terminal value at the end of n periods for a given rate of
interest.

Present Values

Present values are a future amount discounted to the present by some required
rate.

Question:

What is the present value of an amount to be received at the end of a period

when interest rate is involved?

Suppose A1 represent the amount of money you wish to have 1 year from now, Pv
the amount saved and v the annual interest rate.

A1 = PV (1+ v)

If A1 = 1000

R = 10%

PV therefore becomes 1000 = PV (1.1)

PV = 1000 = shs 909.09

1.1

Hence the present value of sh 1000 one year on discounted at a rate of 10

percent p.a is 909.09.

Beyond one period

The present value of shs 1000 to be received 2 years from now is

PV = 1000 = 1000 = shs 826.44

(1+ 0.1)2 1.12

Generally for even cash flows

The present value of shs 1.00 to be received at the end of n years at a rate of r
percent

PV = 1.00 v = Interest rate

(1+r) n n = 1, 2, 3…..n

For uneven cashflows

Year Cashflows r% PVIF CashFlows

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1 1.00 10% 0.909 0.909
2 3.00 10% 0.826 2.479
3 2.00 10% 0.751 1.503

PV = 1 + 3 + 2

(1.1)1 (1.1)2 (1.1)3

PV = (0.909 + 2.479 + 1.503)

= shs 4.891

1 = PVIF (Present Value Interest Factor)

(1 + r) n

ANNUITY

An annuity is a series of even cash flows (inflows or outflows) which are

equidistance and interest rate remains the same for each period.

Illustration of an annuity

Suppose you open a recurrent deposit account with a bank where you deposit shs
100 every end month for a period of 3 years and the bank offers you interest at a
rate of 12 percent per annum throughout the period is a regular annuity. If the
cash flow occur at the end of each period it is called regular annuity, conversely,
when it occurs at the beginning of each period, it is an annuity due.

Future value of an Annuity (Regular)

Future value of a regular annuity earning interest at a rate of r percent for n years
is

FVRA =A (1+r) n – 1

where; A = Contribution each period

r = Rate of interest per period

n = Number of periods in an annuity.

(1 + r) n – 1 is called future value interest

If the investment is made at the beginning of each period, it is called an annuity

due. Such investment would earn an extra period of interest.

For future value of annuity due earning interest at the rate of r percent at the end
of n years is

FVAD = FVRA (1 + r)

OR

FVAD = A (1+r) n
– 1 * (1+r)

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Illustration

Otieno opens a 4 year recurring deposit account with a bank offering interest a
rate of 7 percent per annum. Otieno decides to deposit shs 5,000 per annum.

Question

a) How much money can Otieno expect to get at the end of 4 years assuming
i. Each deposit is made at the end of each year
ii. Each deposit is made at the beginning of each period

Regular Annuity

FVRA =A (1 +r) n
-1

= 5000 (1 +0.07)4-1

0.07

OR

A (FVIFA 7%, 4 ) = 5000 × 4.4399

= shs 22,199.715

ii.Annuity due

FVAD = FVRA (1 +r)

= 22,199.715 × 1.07

= shs 23,753.69505

Present value of an Annuity

This is given by:

Pv = Ax 1 – (1 +r)-t

1 – (1 +r)-t = PVIFA (r%, t)

Illustration

Wanjiku is planning to buy a pension plan which would provide her an annual
pension of 10,000 for the next 20 years. How much should she be willing to pay

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for this pension plan if she wants a return of 6 percent on her investments
assuming the pension is received;

i. At the end of each year

ii. At the beginning of each year

Regular annuity;

PVRA = 1-(1 +r)-t A

PVRA = 1- (1 + 0.06) -20

10,000

0.06

= 1 – (1.06)-20 10,000

0.06

= 1 – 0,311804 10,000

0.06

= (11.4699)10,000

Value of pension now = 114,699.33 if she is to receive 10,000 end of each

period

Annuity due

PVAD = PVRA × (1 +r)

PVAD = 114,699.33 (1 + 0.06)

Pension sum = shs 121,581.2933. If she is to receive shs 10,000 at the beginning
of each period.

VALUATION CONCEPTS

Value of equity, Debt and Preferred stock.

Value of Equity.

Equity is valued using dividend Discount models (DDM)

a) Single period dividend valuation model

The price of a stock for a single period; PO

Po = D 1 + P 1

(1 + ke) (1 +ke)

b) Finite period dividend valuation

n
PO == ∑ t=1 Dt + Pn

(1 + ke)t (1 + ke)n

c) General dividend valuation model

In case distributions tend to infinity the valuation equation becomes,

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 ∞
PO = ∑ t−1 Dt

(1 + Ke) t

When t = ∞

But with constant dividends into perpetuity, the general model simplifies to

PO = D e → K e = D O

Ke PO

d) Dividend growth and cost of Equity

When dividends are retained for growth at a constant rate in perpetuity, the value
of such a stock is,

PO = D1 But Ke > g

Ke – g

Suppose Ke = 10%

g = 8%

D1 = Shs 20

What is the price of a share?

PO = 20 = 20 =shs.1000

0.1 -0.08 0.02

But when g = 0

PO = 20 = Shs 200

0.1

Hence growth potential of a stock increases equity value.

Cost of Equity (Ke)

The cost of equity for a constantly growing dividend (K e)

Ke = D1 + g

PO

Using the example Ke = (20 + 0.08) = 0.1 or 10%

1000

When a share price grows at a rate G, this equals g (annual growth in dividends)
so that share value.

PO = D1 (Gordons Growth Model)

Ke – g

Assume a company stock is trading at shs 4.00 per share forcasted dividend is shs
0.20 and expected to grow at 5%, what is Ke using an appropriate model.

4 = 0.2

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 Ke -0.05

Ke – 0.05 = 0.2

Ke = 0.2 + 0.05

Ke = D1 + g

PO

Ke = 0.2 + 0.05

= (0.05 + 0.05) = 0.1 or 10%

Exercise on dividend valuation

If shares are currently at shs. 2.68 and dividends are expected to grow at 10% per
annum. Dividend paid is shs 0.32. Confirm that the equity capitalization rate
(managerial cut off rate) is 22 percent for new investments.

Assuming all earnings are distributed as dividends

According to MM the current ex-div share price (Po) equals the anticipated
earnings per share (E1) plus ex-div price (P1) at the end of the year discounted at
the shareholders rate of return (Ke).

Finite Period Earnings Model

n
Po = ∑ t=1Et + Pn

(1 + Ke) t (1 + Ke) n

Therefore Div1 (expected dividends) can be substituted for expected earnings (E 1).

General Earnings valuation Model (constant earnings in perpetuity).

If annual earnings are constant in perpetuity, the constant earnings valuation

model becomes;

Po = Et and cost of equity becomes, ke =Et/Po

Ke

Incorporating growth into the model

Po = Et E = Earnings per share (EPS) while cost of equity Ke = Et/Po + g

Ke – g Ke > g

Cost of Preference Capital

This is the dividend (after tax) expected by investors from profits.

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Irredeemable preference share is treated as a perpetual security. The cost
becomes;

Kp = PDIV PDIV = Expected Preference Dividend

Po Po = Issue Price of Preference Share.

Redeemable Preference Shares

This is preference shares with a finite maturity. The formula for computing Bond
Value (price) can be used to compute the cost of redeemable preference shares
Ke using trial & error method.
n
Po = ∑ t=1 PDIVt + Pn

(1+Kp) t
(1+Kp) n

Ke = cost of Preference shares

Pn = price of redeeming the share

Cost of preference is higher than cost of debt because it is after tax distribution.

Cost of External Equity

This is the minimum rate of return that equity shareholders require on funds
supplied by them by purchasing new shares. Cost of internal equity is given by:

Ke = DIV1 +g (cost of internal equity)

Po

The cost of external equity is usually greater than internal equity because the
selling price of new shares may be less than the market price at the time of
announcement of share issue. In this case the cost of equity becomes;

Ke = DIV1 + g (Where Io is issue price of new equity) I0 less than Po.

Io

Cost of debt or yield to maturity (YTM)

When the discount or premium on bonds is adjusted for computing taxes, the
before – tax cost of debt is given by Kd in either of the two formula below.
Compute the cost of debt for a 10 year bond with a market price of shs 90 and a
nominal value of shs.100. The coupon rate 9% per annum.

B =Σ Ct/ (1+ Kd)t + Fn/ (1+ kd)n (trial and error) 9/100 * 100= shs.9. (constant
Coupon)

90= Σ 9/(1+Kd)t + 100/ (1+Kd)10

90= PVIFA,Ke, 10yrs * 9 + 100/(1+Kd)10 use trial and error method.

………..

Alternatively;

Kd = INT + 1/n (F –B) Kd = [9%+ (100-90)/10]/ 100+90/2

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 ½ (F + B) (9+1)/95 = 0.105 =10.5%

F = Face Value

B = Bond Price

INT = Interest

N= term or tenor of the bond.

Weighted Average cost of Capital (WACC)

WACC is the overall cost of capital derived by weighting individual capital costs
based on market values of equity, debt and preference or even retained earnings.
Specific costs are then summed up to arrive at weighted average cost of capital.
The overall cost of capital is determined by the weights of respective capital in
the firm’s capital structure.

WACC = E Ke + D Kd + P KP E +D + P = V

V V V

E = Equity, D = Debt, P = Preference Capital

E = Proportion of Equity in firm capital

D = Proportion (weight) of Debt in firm value

P = Proportion of preference capital in firm value

Shareholder wealth is maximized when cashflows, earnings per share are

discounted at the minimum overall cost of capital (WACC). If the firm is financed
by more than one type of capital.

Illustration

A company has the following capital structure in market value terms

Equity shares shs 8,000,000

(320,000)

Preference shares shs 2,000,000

Debentures shs 6,000,000

Total 16,000,000

A study of the industry show that the required rate of return on equity at 17%.
Debt is currently yielding 13% while preferred stock yields 12%. The company’s
tax rate is 30%.

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Require:

(a) The weighted average cost of capital (WACC)

(b) Explain the difference between marginal average cost of capital and
weighted average cost of capital.

Solution:

WACC = 8,000,000 × 0.17 + 2,000,000 ×0.12 + 6,000,000

1,600,000 1,600,000 1,600,000

(1-0.3) 13%

0.17(0.5) + 0.12(0.125) + 0.091(0.375)

= 0.1341 OR 13.4%

Component costs (marginal costs)

1. Equity = 0.17 (8,000,000) = shs 1,360,000

2. Cost of preference capital = 0.12 (2,000,000) = 240,000
3. Cost of debenture = 0.091 (6,000,000) = 546,000

INVESTMENT DECISIONS

Capital budgeting techniques under condition of certainty.

Discounted cash flow (DCF) Techniques

(a) Net Present Value (NPV)

(b) Internal Rate of Return (IRR)
(c) Profitability Index (PI)
(d) Discounted Payback

Non Discounted Cash flow Techniques

(a) Payback (PB)

(b) Accounting Rate of Return (ARR)

Steps involved in Evaluating an Investment

(a) Estimation of cash flows

(b) Estimation of the required rate of return (opportunity Cost of Capital)
(c) Application of decision rule for making the choice.

Net Present Value Method

This is a discounted cash flow technique that recognizes the time

value of money. It is the present value of future cash flow minus the present
value of initial capital investment. Discounting of cash flow is done using the
required rate of return.

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NPV = PV – Io (or Co)

NPV = C1 + C2 + C3 ………… Cn _______Co

(1+ v) (1+v) 2 (1 +v) 3 (1 + v) n

n
NPV = ∑ (1+Ctr ) t _ C o
t −1

Illustration

A machine costing shs 200,000 will provide an annual net cash flow of shs 60,000
for six years at a cost of capital of 10 percent.

i. Calculate the net present value NPV of the machine

ii. Should the machine be purchased?

Solution

Year Cash flow DCF 10% PV

()200,000 1.000 (200,000)
1 60,000 0.909 54,540
2 60,000 0.826 49,560
3 60,000 0.751 45,060
4 60,000 0.683 40,980
5 60,000 0.621 37,260
6 60,000 0.564 33,840
NPV 61,240

(ii) Decision: the machine should be purchased since the NPV is position

Decision Rule:

Accept if NPV > 0

Reject if NPV < 0

May accept or reject if NPV = 0

For mutually exclusion projects, the rule is to accept the project that produces the
highest positive net present value.

Advantages of NPV

i. Recognizes the time value of money

ii. Uses all cash flows over entire period – life of project.
iii. Measures in absolute terms e.g. Kshs
iv. Value addictivity principle, values for separate assets can be added up.
Disadvantages

i. Difficult to calculate compared to payback and accounting rate of return.

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 ii. Relies on the correct estimation of the cost of capital.
(b)Internal Rate of Return

Also known as yield of a project margin efficiency of capital. It is the cost of

capital for which NPV of a project would be zero.
n
IRR = ∑ (1+Ctv ) t -C o =0
t −1

To determine IRR using the interpolation method

A trial and error method can be used to determine IRR. Here two discounting
levels are chosen, one yielding a positive NPV and another negative NPV.

IRR = DRP + NPP (DFN – DFP)

NPVP - NPVN

NPVP = Positive NPV

NPVN = Negative NPV

DFP = Discount factor yielding positive NPV

DFN = Discount factor yielding negative NPV

Exercise: Use the illustration information above to determine IRR for the machine

Discount level = 10%

NPV (Positive) = shs 61,240

Discount level = 20%

NPVN = (500)

IRR = 10 + 61,240 (20-10)

61,240 + 500

= 19.92%

Decision Rule:

Accept all projects whose IRR are greater than company’s cost of capital r > k

Reject if r < k

May accept or reject if r = k

R = IRR; K = Cost of Capital

If mutually exclusive projects, the rule is to accept the project that produces the
highest IRR

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Advantages of IRR

i. Recognizes time value money

ii. Consider all cash flows over the life of project.
iii. Gives same acceptance rule as NPV
iv. Consistent with shareholder wealth maximum.

Disadvantages of IRR

i. Difficult to calculate
ii. Can give inconsistent result when NPV of a project does not decline with
discount rate.
iii. May fail to indicate a correct choice between mutually exclusion projects.

(c)Profitability Index (PI) Technique

This is the ratio of the present value of cash inflows at the required rate of
investment to the initial cash outlay.

PI = Present Value of Cash inflow

Initial Cash outlay

Present value of cash inflow = NPV + Initial Capital Outlay.

Using previous example

PI = 61,240 + 200,000

200,000

261240 = 1.31

200,000

Decision Rule:

Accept all projects whose PI is positive or greater than 1; reject if PI < 0

(Negative); may accept or reject if PI = 0

(d)Discounted Payback Method

This method improved on the payback method aimed at overcoming in problem of

the time value of money. Here cashflows are discounted before calculation of
payback period is done.

Illustration

A machine will cost shs 300,000 and will provide annual net cash inflow of shs
100,000 for 5 years. The opportunity cost of capital is 10%. Calculate in
discounted payback period of the machine.

Year Cashflow DF PV of cash flows

0 (300,000) 1.000 (300,000)
1 100,000 0.909 90,900
2 100,000 0.826 82,600

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3 100,000 0.751 75,100
4 100,000 0.683 68,300
5 100,000 0.621 62,100
NPV 79,000

Using simple payback period method. The time required to recover the
investment is given by;

300,000 = 3 years but when discounted

100,000

Payback method is applied; it becomes;

= 3 yrs + 51400 × 12 months

68300

= 3 years + 9.031 months

= 3 years 9 months

Advantages of Discounted Payback Method

i. Recognizes the time value of money.

ii. Focuses on the shortness of project to payback initial outlay

Disadvantages of Discounted Payback Method

i. Does not recognize cash flows earned after the payback period
ii. Does not consider risk associated with each project.

Assignment

Discuss non discounted techniques for investment.

Non Discounted cash flow Techniques

(a) Payback period

Considers shortness of the project in terms of duration to recover capital outlay.
The shorter the projects recovery period the more the preference

For a constant or unit annual net cash flow from a project, payback period.

PB = Initial Investment = IO

Annual Net Cash Flow Ct

Decision

Accept projects that satisfy management preferred, predetermined period.

Advantages of Payback

i. Simple to calculate

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 ii. Least exposes the firm to risk (uncertainty) since it focuses on shortness of
project.
iii. Screens for liquidity problem.

Disadvantages of Payback method

i. Does not recognize cashflows earned after payback period.

ii. No recognition for time value of money
iii. Does not consider risks associated with each project

Accounting Rate of Return (ARR) = Average income

Average Investment

IO = 1,200,000, S = 0, P= 400,000; ARR15%

Transaction Cost

Higher issuing and other costs associated with raising long term capital leads to
capital rationing. A company would therefore raise large capital once in a while
rather than small frequent attempts to save on transaction costs.

i. Single Period Rationing

In cases where capital rationing applies, project selection is based on profitability
index.

Profitability Index = Present Value

Initial Outlay

The solution will be guided by the highest ratio of present value to investment
outlay. Appraising projects according to the NPV per shs 1 of investment outlay
can give different ranking from those obtained from the application of NPV rule.

Illustration NPV vs PI for ABC Ltd

Cash flows

Projec Initial cost Year 1 Year 2 PV at 10% NPV (10%) PI

t (m)
A (15) 17 17 30 15 2.6
B (5) 5 10 13 8 2.5
C (12) 12 12 21 9 2.0
D (8) 12 11 20 12 1.7

E (20) 10 10 17 3 0.8

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PI assumes projects are infinitely divisible which its greatest weakness. It is also
applicable for single period projects only.

19