BME TERM PAPER

GROUP 4:
11108 Balaraju Radhika
11135 Mallela Vamshi Krishna
11162 Srikanth N.
11219 K. Kaushik Kumar
11246 Sirisha Chowdari S.
A firm in the business of manufacture of automobile components is considering two mutually
exclusive technologies for a manufacture of hydraulic brakes. These two technologies are
designated as option A and option B with project costs of Rs. 1600 lakh and Rs. 1850 lakhs.
Depending upon various features of the product obtainable from the two technologies the firm
has developed a forecast of cash flows for 5 years which is the life of the project. These cash
flows are as below
Year Option A (Rs.Lakhs) Option B(Rs.Lakhs)
1 350 675
2 475 575
3 625 725
4 575 350
5 350 400
Option A is familiar technology and so the firm feels that the current cost of capital of 13% is the
appropriate discount rate. However option B is considered riskier than option A ad therefore the
firm would like to use a discount rate of 15%, somewhat higher than the current cost of capital.
Calculate the NPV s and IRR s for option A and option B and and assess which option is better
to invest in as per both NPV and IRR rule.
INPUTS OF THE MODEL:
1. Project cost
2. Discount rate
3. Cash flows
DECISION VARIABLE:
1. Discount rate
OBJECTIVE FUNCTION:
1. NPV
METHODOLOGY:
1. Simulation
SOLUTION:


We have calculated the IRR and NPV for the two mutually exclusive projects. Based on IRR rule, Option B is
preferable having larger IRR.(IRR is not concerned about the cost of capital while ranking projects)
Based on NPV rule, option A is preferable having larger NPV.


For different discount rates the NPV varies. As the discount rates increases the NPV decreases. So it is
better to select project with low discount rates. This is calculated using data table.
The graphs for the different discount rates are displayed below.






For different discount rates, the sensitivity of NPV decreases.



For different discount rates and different cash flows, the data table tool is used for calculating the
values. The graphs for the values are displayed below.





The scenario analysis for changes in discount rates are shown below.