Assignment

Technical
Answer 1:
Part a)
NPV = F / [ (1 + r)^n ] where, PV = Present Value, F = Future payment (cash flow), r = Discount
rate, n = the number of periods in the future is based on future cash flows

Rate Year Expected net cash flow

8.20% 1 275000
2 425000
3 300000
NPV ₹ 8,54,013.69

Part b)
NPV = F / [ (1 + r)^n ]
New r = 0.092
NPV = 275000/ [ (1 + 0.092)^1 ] + 425000/ [ (1 + 0.092)^2 ] + 300000/ [ (1 + 0.092)^3 ]
=NPV (0.092, 275000, 425000, 300000)
=₹ 8,38,620.94

Part c)
From this we can see that Higher discount rate decreased the expected present value of the
project.

This is because the higher discount rate indicates that money will grow more rapidly over time
due to the highest rate of earning.

Answer 2:
Part a)
Probabilities given, low=10%, best=60%, high=30%
New Expected Net Cash Flows(in millions),
 E( NCF ¿¿ 1)=(0.1)(−2)+(0)(0.6)+(4)(0.3)=1 ¿
E( NCF ¿¿ 2)=(0.1)(1)+(3)(0.6)+(5)(0.3)=3.4 ¿
E( NCF ¿¿ 3)=(0.1)(4)+(5)(0.6)+(6)(0.3)=5.2¿
E( NCF ¿¿ 4)=(0.1)( 4)+( 5)( 0.6)+(6)(0.3)=5.2 ¿
E( NCF ¿¿ 5)=(0.1)(2)+(4)( 0.6)+(5)(0.3)=4.1¿

Part b)
Given, Risk premiums
Low=3%, Average=6%, High=9%
Since, riskiness is low, Risk premium=3%

Now,

Years to Riskless rate Risk premium (persent) Risk-adjusted

maturity (percent) discount rate
(percent)
1 5.75 3 8.75
2 6 3 9
3 6.25 3 9.25
4 6.5 3 9.5
5 6.75 3 9.75

1
E(PV )= ¿
¿¿
E(PV )=¿ $13.961 million

Part c)
Equity (E) = $32.7 million
Debt (D) = $87.4 million
r E=0.14 , r D =0.07
r WACC =r D ( D /D+ E)+r E ( E /D+ E)
87.4 32.7
= ∗0.07+ ∗0.14=0.089
(87.4 +32.7) (87.4 +32.7)

Now, Expected Present Value,

1
E( PV )= ¿ =$14.186 million
¿¿
Answer 3:
Part a) Rate = 10 1.1
Period Inflow Cost
1 100000 90909.0909 162500
2 100000 82644.6281 0
Sum of 2 periods 173553.7190
NPV 11053.7190

Rate = 15 1.15
Period Inflow Cost
1 100000 86956.5217 162500
2 100000 75614.3667
Sum of 2 periods 162570.8885
NPV 70.8885

Rate = 20 1.2
Period Inflow Cost
1 100000 83333.3333 162500
2 100000 69444.4444
Sum of 2 periods 152777.7778
NPV -9722.2222

Part b)
Rate NPV
10 11053.719
0
15 70.8885
20 -
9722.2222
Answer 4:
Part a) Discount @ 10%

NPV = (-45,000) + (20,000) / (1+0.1)^1 + 15,000 / (1+0.1)^2 + 10,000 / (1+0.1)^3 + 10,000 /

(1+0.1)^4 + 5,000 / (1+0.1)^5
NPV = 3,026.40

Part b) Yes, Current NPV value is 3026.40 considering life of 5 years of project and positive NPV
means that the project is profitable for the organization. Hence, they should invest in this
project. However, NPV will be just 3026/45000 = 6.7% of the investment.

Part c) Discount @ 18%

NPV = (-45,000) + (20,000) / (1+0.18)^1 + 15,000 / (1+0.18)^2 + 10,000 / (1+0.18)^3 + 10,000 /
(1+0.18)^4 + 5,000 / (1+0.18)^5
NPV = - 3,848.33

Part d)
A negative NPV project indicates that the investment is not good. If NPV is negative, then it
means that you're paying more than what the asset is worth.
The project has positive NPV at 10% but while discounting at 18%, the NPV becomes negative
and thus the investment will no longer increase the present value of the firm.

Part e)
Year Expected net cash flow
0 -45000
1 20000
2 15000
3 10000
4 10000
5 5000
Expected NPV @9.5% $3,523
Expected NPV @11% $2,059
Expected NPV @13.25% $3

Answer 5:
Part a)
Pay-back period for both Projects A is 1 Year & Project B is 3 years. Thus Project A can be taken
into consideration from a Pay-back period calculation perspective, since it has a payback period
of 1Year, while B has 3 years.

Part b)
NPV for Project A = -2 + [2/ (1+0.10)^ 1] + [0/(1+0.10)^1] + [0/(1+0.10)^1] + [0/(1+0.10)^4] = -
0.182

NPV for Project B = -2 + [1/ (1+0.10)^ 1] + [0.8/(1+0.10)^1] + [0.6/(1+0.10)^1] + [0.4/(1+0.10)^4] =

0.294

Part c)
Since, the NPV of Project A is negative it should not be taken. But Project B has a positive NPV
which can be taken.

Answer 6:
Part a)
The cumulative expected net cash flow of the project is equal to the cost of the project
(i.e.45000) at the end of the third year. Hence, Payback period of the project is 3 years (or 36
months).

Part b)
As the payback period is higher than 30 months, the management won’t accept this project.

Part c)
The management’s decision under the payback rule will be consistent with maximization of the
firm’s present value when the expected NPV of the project is also positive.

Answer 7:
The payback rule gives too little weight to distant net cash flows and the ROI rule gives them
too much weight because with ROI criterion, distant cash flows are treated as equivalent to
current cash flows. Payback period method ignores the time value of money and the time
pattern of the cash flows generated by the investment project. Hence, it gives too little weight
to distant net cash flows.

Answer 8:
Part a)
 Year A B
1 10 4
2 8 6
3 6 9
4 4 11

Average Net Cash Flow of A = 7

Average Net Cash Flow of B = 7.5
Given, Cost of each project = 20.5
Therefore, ROI for Project A= (7/20.5)*100= 34.14
ROI for Project B= (7.5/20.5)*100= 36.58

Since the ROI of Project A is less than the firm’s target return of 35 percent, the Project A would
be rejected using the rate of return on investment as the criterion.

Answer 9:

Answer 10:
In the case of mutually exclusive investment proposals that compete with one another in such a
way that accepting one automatically excludes accepting the other, the NPV method and the
IRR method may produce contradictory results. The net present value may suggest accepting
one proposal while the internal rate of return may favour another.

A ranking conflict might be triggered by one or more of the following issues:

● Significant disparity in the magnitude (amount) of financial outlays across projects under
consideration.
● Differences in cash flow patterns or timings between proposals
● Differences in service life or uneven project anticipated lifetimes
When confronted with a tough decision between two competing projects, it is better to pick the
one with a higher positive net value by utilising a cut-off rate or a suitable cost of capital.

Answer 11:

Capital rationing is a management strategy of distributing available capital among multiple

investment possibilities, therefore improving the company's bottom line. The business will
continue to accept a mix of projects with a greater net present value (NPV).

The fundamental goal of capital rationing is to ensure that a firm does not overinvest in assets
because of shortage of capital. With insufficient rationing, a firm may see lower-than-expected
returns on its investments and may even enter the stage of financial bankruptcy.

Due to limited funds, capital rationing sometimes leads to opting for small projects which may
not be very profitable in the long run. It may also encourage firms to choose smaller initiatives
with higher returns rather than long-term investments. In addition, rather than maximising
wealth, the approach concentrates on the timing of profits.

To remove, management might consider entering into a licence or franchising deal with
another firm, under which this company would enjoy numerous benefits.

Firms can look for alternate sources of financing, such as:

• Venture Capital or Private Equity
• Debt financing secured by the project's assets
• Efficient Capital Management

Firms ration capital to set limitations or constraints on the amount of money and other
resources set aside for a certain project or investment. Also, it guarantees that money is used
wisely and that the firm does not run out of cash.
Answer 12:
Part a)
Project Expected NPV Cost PV (NPV + Cost) Profitability
Index (PV/Cost)
A $20.00 $10.00 $30.00 $3.00
B $17.00 $10.00 $27.00 $2.70
C $12.00 $5.00 $17.00 $3.40
D $8.00 $5.00 $13.00 $2.60

Part b)
 Constraint Undertaken Projects (in priority)
$5.00 Project C
$10.00 Project C
Project D
$15.00 Project C
Project A
$20.00 Project C
Project A
Project D

Applied
Answer 1:
Part a)
Net cash flow Probability
($, thousands) (percent)
25 5 = 0.05
30 5 = 0.05
35 20 = 0.2
40 30 = 0.3
45 30 = 0.3
50 10 =0.1

ENCF = 25*0.05 + 30*0.05 + 35* 0.2 + 40*0.3 + 45*0.3 + 50*0.1 = $40.25 thousand

Part b)
Applied:
Since in the question it is told 2 years, so we would take the interest rate as 7%

Therefore, EPV = 40.25/(1+7/100)^2 = $35.155 thousand

It is not appropriate to take the risk free rate as the discount rate. The risk free rate does not
take into account fluctuations in expected cash flows. In this case it might be necessary to
provide a risk premium. The risk-adjusted rate should then be used to calculate the discount
rate.

Part c)
rWACC= (E*re+D*rd)/(E+D)
rWACC= (40*10+20*8.5)/(60)
rWACC=9.5%

Therefore taking interest rate as rWACC is EPV = 40.25/(1+9.5/100)^2

=$33.568 thousand
the expected present value of this project using rWACC is
$33.568 thousand

Answer 2:
Attending college for higher education is a Strategic Investment Decision. By definition,
strategic investment decisions are taken for improving the power or status or overall strength
in the market in hope of greater returns in the future. The expenditure on these expenditures
provides benefits in the long term and does not yield immediate return. In terms of college, this
would be our basic career after graduating it, building networks & learning in overall.
The various factors while taking this decision were:- College (& its status),NIRF & other similar
rankings, Fees, Average package after placement, Faculties, Alumni base & bonding, sometimes
area, etc.
Majorly, the factors to go to graduate school differ in conditions like lack or sudden event due
to which the college enthusiast has to drop his future education plans & work to support
himself or family, some situation when graduating from Foreign colleges looked more
prospective, or some may ponder upon some idea of startup or business or any such similar
thing which would prompt him to drop education plan & get directly into doing that activity like
business, etc.

Answer 3:
Part a)
The firm should calculate the NPV to take the  decision. As only NPV >0 should be considered
for projects. Other factors to see: ROI and payback period.

Part b)
Data required would be:
a) Market size
b) Number and position of competitors
c)Expected revenue
d)Expected costs
 
Part c)
Data can be collected through primary  (Survey) and Secondary Research

Answer 4:

Project A : The NPV after subtracting initial cost is negative but after adding resale value is
highest. hence this project can be undertaken

Project B: The NPV after subtracting initial cost is negative but after adding resale value is also
negative. hence this project must not be considered

Project C: The NPV after subtracting initial cost is positive and after adding resale value is also
positive. Hence this project can be undertaken

Project D: The NPV after subtracting initial cost is positive and after adding resale value is also
positive. Hence this project can be undertaken

Answer 5:
IRR = Discount rate @NPV=0

Project A B C D
Cost -US$1,23,000 -US$89,200 -US$56,600 -US$55,800
2002 US$30,000 US$50,000 US$20,000 US$40,000
net
2003 US$30,000 US$50,000 US$20,000 US$20,000
Cash
2004 US$30,000 US$0 US$20,000 US$10,000
flow
2005 US$30,000 US$0 US$20,000 US$0
 Year end scrap or
resale value of 2005 US$50,000 US$0 US$10,000 US$0

IRR 10.92% 7.97% 19.31% 15.93%

NPV @ (IRR+1)% rate -US$45,572 -US$25,772 -US$18,405 -US$14,816

NPV @ (IRR-1)% rate US$31,59,14,15,432 US$10,55,17,766 US$28,51,00,038 US$2,16,81,501

Evaluation as per IRR calculation :

Project
It generates moderate return of 10.92%, thus generating a negative NPV at 15% discount.
A
Project
It is the least attractive investment with a av return of 7.97%
B
Project
Based on IRR calculation,Project C is the ideal investment with highest returns.(19.31%)
C
Project Project D is the second most ideal investment, with a return close to 15.93%, thus generating a
D positive NPV despite a high dicount factor of 15%

Answer 6:

cost 123000

2002 30000 26086.96

2003 30000 22684.31 As the NPV is in positive, therefore, the

project should be undertaken

2004 30000 19725.49

2005 100000 57175.32

 ENPV 2672.078

Rate = 15 1.15

Answer 7:
Cost 86800
2002 50000 =50000/1.099801 = 45462.76
2003 50000 =50000/(1.099801^2) = 41337.24
2004 0 0
2005 0 0
ENPV (45462.76+41337.24)-86800 = 0.000132
IRR 9.9801337 =(1+(IRR/100)=1.099801