Project Evaluation and Feasibility Analysis

Problems’ Solutions Project Evaluation
Chapter 4 MARKET AND DEMAND ANALYSIS
1. We have to estimate the parameters a and b in the linear relationship

Yt = a + bT
Using the least squares method.
According to the least squares method the parameters are:
∑TY–nTY
b=
∑T2–nT2
a = Y – bT
The parameters are calculated below:
Calculation in the Least Squares Method
T Y TY T2
1 2,000 2,000 1
2 2,200 4,400 4
3 2,100 6,300 9
4 2,300 9,200 16
5 2,500 12,500 25
6 3,200 19,200 36
7 3,600 25,200 49
8 4,000 32,000 64
9 3,900 35,100 81
10 4,000 40,000 100
11 4,200 46,200 121
12 4,300 51,600 144
13 4,900 63,700 169
14 5,300 74,200 196
2
∑ T = 105 ∑ Y = 48,500 ∑ TY = 421,600 ∑ T = 1,015
T = 7.5 Y = 3,464
∑TY–nTY 421,600 – 14 x 7.5 x 3,464

b= =
∑T2–nT2 1,015 – 14 x 7.5 x 7.5
57,880
= = 254
227.5
a = Y – bT
= 3,464 – 254 (7.5)
= 1,559
Thus linear regression is
Y = 1,559 + 254 T
2. In general, in exponential smoothing the forecast for t + 1 is
Ft + 1 = Ft + α et
Where Ft + 1 = forecast for year ) α = smoothing parameter

et = error in the forecast for year t = St = Ft
F1 is given to be 2100 and α is given to be 0.3
The forecasts for periods 2 to 14 are calculated below:
1 By M. Iftikhar Mubbashir
Period t Data (St) Forecast Error Forecast for t + 1
(Ft) (et St =Ft) (Ft + 1 = Ft + α et)
1 2,000 2100.0 -100 F2 = 2100 + 0.3 (-100) = 2070

2 2,200 2070 130 F3 = 2070 + 0.3(130) = 2109
3 2,100 2109.0 -9 F4 = 2109 + 0.3 (-9) = 2111.7
4 2,300 2111.7 188.3 F5 = 2111.7 + 0.3(188.3) = 2168.19
5 2,500 2168.19 331.81 F6 = 2168.19 + 0.3(331.81) = 2267.7
6 3,200 2267.7 932.3 F7 = 2267.7 + 0.3(9332.3) = 2547.4
7 3,600 2547.4 1052.6 F8 = 2547.4 + 0.3(1052.6) = 2863.2
8 4,000 2863.2 1136.8 F9 = 2863.2 + 0.3(1136.8) = 3204.24
9 3,900 3204.24 695.76 F10 = 33204.24 + 0.3(695.76) = 3413.0
10 4,000 3413 587.0 F11 = 3413.0 + 0.3(587) = 3589.1
11 4,200 3589.1 610.9 F12 = 3589.1 + 0.3(610.9) = 3773.4
12 4,300 3772.4 527.6 F13 = 3772.4 + 0.3(527.6) = 3930.7
13 4,900 3930.7 969.3 F14 = 3930.7 + 0.3(969.3) = 4221.5
3. According to the moving average method

St + S t – 1 +…+ S t – n +1
Ft + 1 =
n
where Ft + 1 = forecast for the next period
St = sales for the current period
n = period over which averaging is done
Given n = 3, the forecasts for the period 4 to 14 are given below:
Period t Data (St) Forecast Forecast for t + 1

(Ft) Ft + 1 = (St+ S t – 1 + S t – 2)/ 3
1 2,000
2 2,200
3 2,100 F4 = (2000 + 2200 + 2100)/3 = 2100
4 2,300 2100 F5 =(2200 + 2100 + 2300)/3= 2200
5 2,500 2200 F6 = (2100 + 2300 + 2500)/3 = 2300
6 3,200 2300 F7 = (2300 + 2500 + 3200)/3= 2667
7 3,600 2667 F8 = (2500 + 3200 + 3600)/3 = 3100
8 4,000 3100 F9 = (3200 + 3600 + 4000)/3 = 3600
9 3,900 3600 F10 = (3600 + 4000 + 3900)/3 = 3833
10 4,000 3833 F11 = (4000 + 3900 + 4000)/3 =3967
11 4,200 3967 F12 =(3900 + 4000 + 4200)/3 = 4033
12 4,300 4033 F13 = (4000 + 4200 + 4300)/3 = 4167
13 4,900 4167 F14 = (4200 + 4300 + 4900) = 4467
14 5,300 4467
4.
Q1 = 60
Q2 = 70
I1 = 1000
I2 = 1200
Q1 – Q2 I1 + I2
Income Elasticity of Demand E1 = x
I2 - I1 Q2 – Q1
E1 = Income Elasticity of Demand
Q1 = Quantity demanded in the base year
Q2 = Quantity demanded in the following year
I1 = Income level in base year
I2 = Income level in the following year
70 – 60 1000 + 1200
E1 = x
1200 – 1000 70 + 60
22000
E1 = = 0.846
26000
5.
P1 = Rs.40
P2 = Rs.50
Q1 = 1,00,000
Q2 = 95,000
Q2 – Q1 P1 + P2
Price Elasticity of Demand = Ep = x
P2 –P1 Q2 + Q1
P1 , Q1 = Price per unit and quantity demanded in the base year

P2, Q2 = Price per unit and quantity demanded in the following year
Ep = Price Elasticity of Demand
95000 - 100000 40 + 50
Ep = x
50 - 40 95000 + 100000
- 45
Ep = = - 0.0231
1950
Chapter 6 FINANCIAL ESTIMATES AND PROJECTIONS
1. Projected Cash Flow Statement (Rs. in million)
Sources of Funds
Profit before interest and tax 4.5
Depreciation provision for the year 1.5
Secured term loan 1.0
Total (A) 7.0
Disposition of Funds
Capital expenditure 1.50
Increase in working capital∗ 0.35
Repayment of term loan 0.50
Interest 1.20
Tax 1.80
Dividends 1.00
Total (B) 6.35
Opening cash balance 1.00

Net surplus (deficit) (A – B) 0.65
Closing cash balance 1.65
Projected Balance Sheet (Rs. in million)

Liabilities Assets
Share capital 5.00 Fixed assets 11.00
Reserves & surplus 4.50 Investments .50
Secured loans 4.50 Current assets 12.85
Unsecured loans 3.00 * Cash 1.65
Current liabilities 6.30 * Receivables 4.20
& provisions 1.05 * Inventories 7.00
24.35 24.35
2. Projected Income Statement for the 1st Operating Year

Rs.
Sales 4,500
Cost of sales 3,000
Depreciation 319
Interest 1,044
Write off of Preliminary expenses 15
Net profit 122
Projected Cash Flow Statements
Construction period 1st Operating year
Sources
Share capital 1800 -
Term loan 3000 600
Short-term bank borrowing 1800
∗
Working capital here is defined as :
(Current assets other than cash) – (Current liabilities other than bank borrowings)
In this case inventories increase by 0.5 million, receivables increase by 0.2 million and current liabilities and provisions
increase by 0.35 million. So working capital increases by 0.35 million
Profit before interest and tax 1166
Depreciation 319
Write off preliminary expenses 15
4800 3900
Uses
Capital expenditure 3900 -
Current assets (other than cash) - 2400
Interest - 1044
Preliminary expenses 150 -
Pre-operative expenses 600 -
4650 3444
Opening cash balance 0 150
Net surplus / deficit 150 456
Closing balance 150 606
Projected Balance Sheet

Liabilities 31/3/n+1 31/3/n+2 Assets 31/3/n+1 31/3/n+2
Share capital 1800 1800 Fixed assets (net) 4500 4181
Reserves & surplus - 122
Secured loans : Current assets
- Term loan 3000 3600 - Cash 150 606
- Short-term bank 1800 Other current assets 2400
borrowing
Unsecured loans - - Miscellaneous
expenditures & losses
Current liabilities and - Preliminary 150 135
provisions expenses
4800 7322 4800 7322
Notes :
i. Allocation of Pre-operative Expenses: Rs.
Type Costs before Allocation Costs after
allocation allocation
Land 120 19 139
Building 630 97 727
Plant & machinery 2700 415 3115
Miscellaneous fixed assets 450 69 519
3900 600 4500
ii. Depreciation Schedule:

Land Building Plant & machinery M. Fixed assets Total (Rs.)
Opening balance 139 727 3115 519 4500
Depreciation - 25 252 42 319
Closing balance 139 702 2863 477 4181
iii. Interest Schedule:

Interest on term loan of Rs.3600 @20% = Rs.720
Interest on short term bank borrowings of Rs,1800 @ 18% = Rs.324
= Rs.1044
Chapter 7 THE TIME VALUE OF MONEY
1. Value five years hence of a deposit of Rs.1,000 at various interest rates is as follows:
r = 8% FV5 = 1000 x FVIF (8%, 5 years)

= 1000 x 1.469 = Rs.1469
r = 10% FV5 = 1000 x FVIF (10%, 5 years)

= 1000 x 1.611 = Rs.1611
r = 12% FV5 = 1000 x FVIF (12%, 5 years)

= 1000 x 1.762 = Rs.1762
r = 15% FV5 = 1000 x FVIF (15%, 5 years)

= 1000 x 2.011 = Rs.2011
2. Rs.160,000 / Rs. 5,000 = 32 = 25
According to the Rule of 72 at 12 percent interest rate doubling takes place

approximately in 72 / 12 = 6 years
So Rs.5000 will grow to Rs.160,000 in approximately 5 x 6 years = 30 years
3. In 12 years Rs.1000 grows to Rs.8000 or 8 times. This is 23 times the initial deposit.
Hence doubling takes place in 12 / 3 = 4 years.
According to the Rule of 69, the doubling period is:
0.35 + 69 / Interest rate
Equating this to 4 and solving for interest rate, we get
Interest rate = 18.9%.
4. Saving Rs.2000 a year for 5 years and Rs.3000 a year for 10 years thereafter is equivalent to
saving Rs.2000 a year for 15 years and Rs.1000 a year for the years 6 through 15.
Hence the savings will cumulate to:
2000 x FVIFA (10%, 15 years) + 1000 x FVIFA (10%, 10 years)

= 2000 x 31.772 + 1000 x 15.937 = Rs.79481.
5. Let A be the annual savings.
A x FVIFA (12%, 10 years) = 1,000,000

A x 17.549 = 1,000,000
So A = 1,000,000 / 17.549 = Rs.56,983.
6. 1,000 x FVIFA (r, 6 years) = 10,000
FVIFA (r, 6 years) = 10,000 / 1000 = 10
From the tables we find that
FVIFA (20%, 6 years) = 9.930

FVIFA (24%, 6 years) = 10.980
Using linear interpolation in the interval, we get:
20% + (10.000 – 9.930)

r= x 4% = 20.3%
(10.980 – 9.930)
7. 1,000 x FVIF (r, 10 years) = 5,000

FVIF (r,10 years) = 5,000 / 1000 = 5

FVIF (16%, 10 years) = 4.411
FVIF (18%, 10 years) = 5.234
Using linear interpolation in the interval, we get:
(5.000 – 4.411) x 2%
r = 16% + = 17.4%
(5.234 – 4.411)
8. The present value of Rs.10,000 receivable after 8 years for various discount rates (r ) are:
r = 10% PV = 10,000 x PVIF(r = 10%, 8 years)
= 10,000 x 0.467 = Rs.4,670
r = 12% PV = 10,000 x PVIF (r = 12%, 8 years)

= 10,000 x 0.404 = Rs.4,040
r = 15% PV = 10,000 x PVIF (r = 15%, 8 years)

= 10,000 x 0.327 = Rs.3,270
9. Assuming that it is an ordinary annuity, the present value is:
2,000 x PVIFA (10%, 5years)

= 2,000 x 3.791 = Rs.7,582
10. The present value of an annual pension of Rs.10,000 for 15 years when r = 15% is:
10,000 x PVIFA (15%, 15 years)

= 10,000 x 5.847 = Rs.58,470
The alternative is to receive a lump-sum of Rs.50,000.
Obviously, Mr. Jingo will be better off with the annual pension amount of Rs.10,000.
11. The amount that can be withdrawn annually is:

100,000 100,000
A = ------------------ ------------ = ----------- = Rs.10,608
PVIFA (10%, 30 years) 9.427
12. The present value of the income stream is:
1,000 x PVIF (12%, 1 year) + 2,500 x PVIF (12%, 2 years)

+ 5,000 x PVIFA (12%, 8 years) x PVIF(12%, 2 years)
= 1,000 x 0.893 + 2,500 x 0.797 + 5,000 x 4.968 x 0.797 = Rs.22,683.
13. The present value of the income stream is:
2,000 x PVIFA (10%, 5 years) + 3000/0.10 x PVIF (10%, 5 years)

= 2,000 x 3.791 + 3000/0.10 x 0.621
= Rs.26,212
14. To earn an annual income of Rs.5,000 beginning from the end of 15 years from now, if the
deposit earns 10% per year a sum of
Rs.5,000 / 0.10 = Rs.50,000
is required at the end of 14 years. The amount that must be deposited to get this sum is:
Rs.50,000 / PVIF (10%, 14 years) = Rs.50,000 / 3.797 = Rs.13,165
15. Rs.20,000 =- Rs.4,000 x PVIFA (r, 10 years)

PVIFA (r,10 years) = Rs.20,000 / Rs.4,000 = 5.00
From the tables we find that:
PVIFA (15%, 10 years) = 5.019

PVIFA (18%, 10 years) = 4.494
Using linear interpolation we get:
5.019 – 5.00
r = 15% + ---------------- x 3%
5.019 – 4.494
= 15.1%
16. PV (Stream A) = Rs.100 x PVIF (12%, 1 year) + Rs.200 x

PVIF (12%, 2 years) + Rs.300 x PVIF(12%, 3 years) + Rs.400 x
PVIF (12%, 4 years) + Rs.500 x PVIF (12%, 5 years) +
Rs.600 x PVIF (12%, 6 years) + Rs.700 x PVIF (12%, 7 years) +
Rs.800 x PVIF (12%, 8 years) + Rs.900 x PVIF (12%, 9 years) +
Rs.1,000 x PVIF (12%, 10 years)
= Rs.100 x 0.893 + Rs.200 x 0.797 + Rs.300 x 0.712

+ Rs.400 x 0.636 + Rs.500 x 0.567 + Rs.600 x 0.507
+ Rs.700 x 0.452 + Rs.800 x 0.404 + Rs.900 x 0.361
+ Rs.1,000 x 0.322
= Rs.2590.9
Similarly,
PV (Stream B) = Rs.3,625.2
PV (Stream C) = Rs.2,851.1
17. FV5 = Rs.10,000 [1 + (0.16 / 4)]5x4

= Rs.10,000 (1.04)20
= Rs.10,000 x 2.191
= Rs.21,910
18. FV5 = Rs.5,000 [1+( 0.12/4)] 5x4

= Rs.5,000 (1.03)20
= Rs.5,000 x 1.806
= Rs.9,030
19. A B C
Stated rate (%) 12 24 24

Frequency of compounding 6 times 4 times 12 times
Effective rate (%) (1 + 0.12/6) - 1 (1+0.24/4) –1 (1 + 0.24/12)12-1
6 4
= 12.6 = 26.2 = 26.8

Difference between the
effective rate and stated
rate (%) 0.6 2.2 2.8
20. Investment required at the end of 8th year to yield an income of Rs.12,000 per year from
the end of 9th year (beginning of 10th year) for ever:
Rs.12,000 x PVIFA(12%, ∞ )
= Rs.12,000 / 0.12 = Rs.100,000
To have a sum of Rs.100,000 at the end of 8th year , the amount to be deposited now is:
Rs.100,000 Rs.100,000
= = Rs.40,388
PVIF(12%, 8 years) 2.476
21. The interest rate implicit in the offer of Rs.20,000 after 10 years in lieu of Rs.5,000 now is:
Rs.5,000 x FVIF (r,10 years) = Rs.20,000
Rs.20,000
FVIF (r,10 years) = = 4.000
Rs.5,000

FVIF (15%, 10 years) = 4.046
This means that the implied interest rate is nearly 15%.
I would choose Rs.20,000 for 10 years from now because I find a return of 15% quite
acceptable.
22. FV10 = Rs.10,000 [1 + (0.10 / 2)]10x2

= Rs.10,000 (1.05)20
= Rs.10,000 x 2.653
= Rs.26,530
If the inflation rate is 8% per year, the value of Rs.26,530 10 years from now, in terms of
the current rupees is:
Rs.26,530 x PVIF (8%,10 years)
= Rs.26,530 x 0.463 = Rs.12,283
23. A constant deposit at the beginning of each year represents an annuity due.
PVIFA of an annuity due is equal to : PVIFA of an ordinary annuity x (1 + r)
To provide a sum of Rs.50,000 at the end of 10 years the annual deposit should be
Rs.50,000
A = FVIFA(12%, 10 years) x (1.12)
Rs.50,000
= = Rs.2544
17.549 x 1.12
24. The discounted value of Rs.20,000 receivable at the beginning of each year from 2005 to
2009, evaluated as at the beginning of 2004 (or end of 2003) is:
Rs.20,000 x PVIFA (12%, 5 years)

= Rs.20,000 x 3.605 = Rs.72,100.
The discounted value of Rs.72,100 evaluated at the end of 2000 is
Rs.72,100 x PVIF (12%, 3 years)

= Rs.72,100 x 0.712 = Rs.51,335
If A is the amount deposited at the end of each year from 1995 to 2000 then
A x FVIFA (12%, 6 years) = Rs.51,335
A x 8.115 = Rs.51,335
A = Rs.51,335 / 8.115 = Rs.6326
25. The discounted value of the annuity of Rs.2000 receivable for 30 years, evaluated as at the
end of 9th year is:
Rs.2,000 x PVIFA (10%, 30 years) = Rs.2,000 x 9.427 = Rs.18,854
The present value of Rs.18,854 is:
Rs.18,854 x PVIF (10%, 9 years)
= Rs.18,854 x 0.424
= Rs.7,994
26. 30 percent of the pension amount is
0.30 x Rs.600 = Rs.180
Assuming that the monthly interest rate corresponding to an annual interest rate of
12% is 1%, the discounted value of an annuity of Rs.180 receivable at the end of each
month for 180 months (15 years) is:
Rs.180 x PVIFA (1%, 180)
(1.01)180 - 1
Rs.180 x ---------------- = Rs.14,998
.01 (1.01)180
If Mr. Ramesh borrows Rs.P today on which the monthly interest rate is 1%
P x (1.01)60 = Rs.14,998
P x 1.817 = Rs.14,998
Rs.14,998
P = ------------ = Rs.8254
1.817
27. Rs.300 x PVIFA(r, 24 months) = Rs.6,000
PVIFA (4%,24) = Rs.6000 / Rs.300 = 20
From the tables we find that:

PVIFA(1%,24) = 21.244
PVIFA (2%, 24) = 18.914
Using a linear interpolation
21.244 – 20.000
r = 1% + ---------------------- x 1%
21.244 – 18,914
= 1.53%
Thus, the bank charges an interest rate of 1.53% per month.
The corresponding effective rate of interest per annum is
[ (1.0153)12 – 1 ] x 100 = 20%
28. The discounted value of the debentures to be redeemed between 8 to 10 years evaluated at
the end of the 5th year is:
Rs.10 million x PVIF (8%, 3 years)
+ Rs.10 million x PVIF (8%, 4 years)
+ Rs.10 million x PVIF (8%, 5 years)
= Rs.10 million (0.794 + 0.735 + 0.681)
= Rs.2.21 million
If A is the annual deposit to be made in the sinking fund for the years 1 to 5, then
A x FVIFA (8%, 5 years) = Rs.2.21 million
A x 5.867 = Rs.2.21 million
A = 5.867 = Rs.2.21 million
A = Rs.2.21 million / 5.867 = Rs.0.377 million
29. Let `n’ be the number of years for which a sum of Rs.20,000 can be withdrawn annually.
Rs.20,000 x PVIFA (10%, n) = Rs.100,000
PVIFA (15%, n) = Rs.100,000 / Rs.20,000 = 5.000
PVIFA (10%, 7 years) = 4.868
PVIFA (10%, 8 years) = 5.335
Thus n is between 7 and 8. Using a linear interpolation we get
5.000 – 4.868
n=7+ ----------------- x 1 = 7.3 years
5.335 – 4.868
30. Equated annual installment = 500000 / PVIFA(14%,4)

= 500000 / 2.914
= Rs.171,585
Loan Amortization Schedule
Beginning Annual Principal Remaining

Year amount installment Interest repaid balance
1 500000 171585 70000 101585 398415
2 398415 171585 55778 115807 282608
3 282608 171585 39565 132020 150588
4 150588 171585 21082 150503 85*
(*) rounding off error
31. Define n as the maturity period of the loan. The value of n can be obtained from the
equation.
200,000 x PVIFA(13%, n) = 1,500,000
PVIFA (13%, n) = 7.500
From the tables or otherwise it can be verified that PVIFA(13,30) = 7.500
Hence the maturity period of the loan is 30 years.
32. Expected value of iron ore mined during year 1 = Rs.300 million
Expected present value of the iron ore that can be mined over the next 15 years assuming
a price escalation of 6% per annum in the price per ton of iron
1 – (1 + g)n / (1 + i)n
= Rs.300 million x ------------------------
i-g
= Rs.300 million x 1 – (1.06)15 / (1.16)15

0.16 – 0.06
= Rs.300 million x (0.74135 / 0.10)

= Rs.2224 million
Chapter 8 INVESTMENT CRITERIA
1.(a) NPV of the project at a discount rate of 14%.
100,000 200,000
= - 1,000,000 + ---------- + ------------
(1.14) (1.14)2
300,000 600,000 300,000

+ ----------- + ---------- + ----------
(1.14)3 (1.14)4 (1.14)5
= - 44837
(b) NPV of the project at time varying discount rates
= - 1,000,000
100,000
+
(1.12)
200,000
+
(1.12) (1.13)
300,000
+
(1.12) (1.13) (1.14)
600,000
+
(1.12) (1.13) (1.14) (1.15)
300,000
+
(1.12) (1.13) (1.14)(1.15)(1.16)
= - 1,000,000 + 89286 + 158028 + 207931 + 361620 + 155871

= - 27264
2. Investment A
a) Payback period = 5 years
b) NPV = 40000 x PVIFA (12%,10) – 200 000
= 26000
c) IRR (r ) can be obtained by solving the equation:
40000 x PVIFA (r, 10) = 200000
i.e., PVIFA (r, 10) = 5.000
From the PVIFA tables we find that
PVIFA (15%,10) = 5.019
PVIFA (16%,10) = 4.883
Linear interpolation in this range yields
r = 15 + 1 x (0.019 / 0.136)
= 15.14%
d) BCR = Benefit Cost Ratio

= PVB / I
= 226,000 / 200,000 = 1.13
Investment B
a) Payback period = 9 years
b) NP V = 40,000 x PVIFA (12%,5)

+ 30,000 x PVIFA (12%,2) x PVIF (12%,5)
+ 20,000 x PVIFA (12%,3) x PVIF (12%,7)
- 300,000
= (40,000 x 3.605) + (30,000 x 1.690 x 0.567)

+ (20,000 x 2.402 x 0.452) – 300,000
= - 105339
c) IRR (r ) can be obtained by solving the equation

40,000 x PVIFA (r, 5) + 30,000 x PVIFA (r, 2) x PVIF (r,5) +
20,000 x PVIFA (r, 3) x PVIF (r, 7) = 300,000
Through the process of trial and error we find that

r = 1.37%
d) BCR = PVB / I
= 194,661 / 300,000 = 0.65
Investment C
a) Payback period lies between 2 years and 3 years. Linear interpolation in
This range provides an approximate payback period of 2.88 years.
b) NPV = 80.000 x PVIF (12%,1) + 60,000 x PVIF (12%,2)

+ 80,000 x PVIF (12%,3) + 60,000 x PVIF (12%,4)
+ 80,000 x PVIF (12%,5) + 60,000 x PVIF (12%,6)

+ 40,000 x PVIFA (12%,4) x PVIF (12%,6)
- 210,000
= 111,371
c) IRR (r) is obtained by solving the equation

80,000 x PVIF (r,1) + 60,000 x PVIF (r,2) + 80,000 x PVIF (r,3)
+ 60,000 x PVIF (r,4) + 80,000 x PVIF (r,5) + 60,000 x PVIF (r,6)
+ 40000 x PVIFA (r,4) x PVIF (r,6) = 210000
Through the process of trial and error we get

r = 29.29%
d) BCR = PVB / I = 321,371 / 210,000 = 1.53
Investment D
a) Payback period lies between 8 years and 9 years. A linear interpolation in this range
provides an approximate payback period of 8.5 years.
8 + (1 x 100,000 / 200,000)
b) NPV = 200,000 x PVIF (12%,1)

+ 20,000 x PVIF (12%,2) + 200,000 x PVIF (12%,9)
+ 50,000 x PVIF (12%,10)
- 320,000
= - 37,160
c) IRR (r ) can be obtained by solving the equation

200,000 x PVIF (r,1) + 200,000 x PVIF (r,2)
+ 200,000 x PVIF (r,9) + 50,000 x PVIF (r,10)
= 320000
Through the process of trial and error we get r = 8.45%
d) BCR = PVB / I = 282,840 / 320,000 = 0.88

Comparative Table
Investment A B C D
a) Payback period (in years) 5 9 2.88 8.5
b) NPV @ 12% 26000 -105339 111371 -37160
c) IRR (%) 15.14 1.37 29.29 8.45
d) BCR 1.13 0.65 1.53 0.88
Among the four alternative investments, the investment to be chosen is ‘C’ because it has
the
a. Lowest payback period
b. Highest NPV
c. Highest IRR
d. Highest BCR
3. IRR (r) can be calculated by solving the following equations for the value of r.
60000 x PVIFA (r,7) = 300,000
i.e., PVIFA (r,7) = 5.000
Through a process of trial and error it can be verified that r = 9.20% p.a.
4. The IRR (r) for the given cash flow stream can be obtained by solving the following
equation for the value of r.
-3000 + 9000 / (1+r) – 3000 / (1+r) = 0
Simplifying the above equation we get
r = 1.61, -0.61; (or) 161%, (-)61%
Note: Given two changes in the signs of cash flow, we get two values for the IRR of the
cash flow stream. In such cases, the IRR rule breaks down.
5. Define NCF as the minimum constant annual net cash flow that justifies the purchase of the
given equipment. The value of NCF can be obtained from the equation
NCF x PVIFA (10%,8) = 500000
NCF = 500000 / 5.335
= 93271
6. Define I as the initial investment that is justified in relation to a net annual cash inflow of
25000 for 10 years at a discount rate of 12% per annum. The value of I can be obtained
from the following equation
25000 x PVIFA (12%,10) = I
i.e., I = 141256
7. PV of benefits (PVB) = 25000 x PVIF (15%,1)

+ 40000 x PVIF (15%,2)
+ 50000 x PVIF (15%,3)
+ 40000 x PVIF (15%,4)
+ 30000 x PVIF (15%,5)
= 122646 (A)
Investment = 100,000 (B)
Benefit cost ratio = 1.23 [= (A) / (B)]
8. The NPV’s of the three projects are as follows:

Project
P Q R
Discount rate
0% 400 500 600
5% 223 251 312
10% 69 40 70
15% - 66 - 142 - 135
25% - 291 - 435 - 461
30% - 386 - 555 - 591
9. NPV profiles for Projects P and Q for selected discount rates are as follows:
(a) Project
P Q
Discount rate (%)
0 2950 500
5 1876 208
10 1075 - 28
15 471 - 222
20 11 - 382
b) (i) The IRR (r ) of project P can be obtained by solving the following

equation for `r’.
-1000 -1200 x PVIF (r,1) – 600 x PVIF (r,2) – 250 x PVIF (r,3)
+ 2000 x PVIF (r,4) + 4000 x PVIF (r,5) = 0
Through a process of trial and error we find that r = 20.13%
(ii) The IRR (r') of project Q can be obtained by solving the following equation for r'
-1600 + 200 x PVIF (r',1) + 400 x PVIF (r',2) + 600 x PVIF (r',3)
+ 800 x PVIF (r',4) + 100 x PVIF (r',5) = 0
Through a process of trial and error we find that r' = 9.34%.
c) From (a) we find that at a cost of capital of 10%

NPV (P) = 1075
NPV (Q) = - 28
Given that NPV (P), NPV (Q) and NPV (P) > 0, I would choose project P.
From (a) we find that at a cost of capital of 20%
NPV (P) = 11
NPV (Q) = - 382
Again NPV (P) > NPV (Q); and NPV (P) > 0. I would choose project P.
d) Project P
PV of investment-related costs
= 1000 x PVIF (12%,0)
+ 1200 x PVIF (12%,1) + 600 x PVIF (12%,2)
+ 250 x PVIF (12%,3)
= 2728
TV of cash inflows = 2000 x (1.12) + 4000 = 6240
The MIRR of the project P is given by the equation:
2728 = 6240 x PVIF (MIRR,5)
(1 + MIRR)5 = 2.2874
MIRR = 18%
(c) Project Q
PV of investment-related costs = 1600
TV of cash inflows @ 15% p.a. = 2772
The MIRR of project Q is given by the equation:
16000 (1 + MIRR)5 = 2772
MIRR = 11.62%
10.
(a) Project A
NPV at a cost of capital of 12%
= - 100 + 25 x PVIFA (12%,6)
= Rs.2.79 million
IRR (r ) can be obtained by solving the following equation for r.

25 x PVIFA (r,6) = 100
i.e., r = 12,98%
Project B
NPV at a cost of capital of 12%
= - 50 + 13 x PVIFA (12%,6)
= Rs.3.45 million
IRR (r') can be obtained by solving the equation

13 x PVIFA (r',6) = 50
i.e., r' = 14.40% [determined through a process of trial and error]
(b) Difference in capital outlays between projects A and B is Rs.50 million

Difference in net annual cash flow between projects A and B is Rs.12 million.
NPV of the differential project at 12%
= -50 + 12 x PVIFA (12%,6)
= Rs.3.15 million
IRR (r'') of the differential project can be obtained from the equation
12 x PVIFA (r'', 6) = 50
i.e., r'' = 11.53%
11.
(a) Project M
The pay back period of the project lies between 2 and 3 years. Interpolating in
this range we get an approximate pay back period of 2.63 years.
Project N
The pay back period lies between 1 and 2 years. Interpolating in this range we
get an approximate pay back period of 1.55 years.
(b) Project M
Cost of capital = 12% p.a
PV of cash flows up to the end of year 2 = 24.97
Discounted pay back period (DPB) lies between 3 and 4 years. Interpolating in this range
we get an approximate DPB of 3.1 years.
Project N
Cost of capital = 12% per annum
DPB lies between 1 and 2 years. Interpolating in this range we get an approximate DPB of
1.92 years.
(c) Project M
NPV = - 50 + 11 x PVIFA (12%,1)
+ 19 x PVIF (12%,2) + 32 x PVIF (12%,3)
+ 37 x PVIF (12%,4)
= Rs.21.26 million
Project N
NPV = Rs.20.63 million
Since the two projects are independent and the NPV of each project is (+) ve, both the
projects can be accepted. This assumes that there is no capital constraint.
(d) Project M
Project N
Since the two projects are mutually exclusive, we need to choose the project with the higher
NPV i.e., choose project M.
Note : The MIRR can also be used as a criterion of merit for choosing between the two
projects because their initial outlays are equal.
(e) Project M
NPV = 16.13 million
Project N
Cost of capital: 15% per annum
Again the two projects are mutually exclusive. So we choose the project with the higher
NPV, i.e., choose project N.
(f) Project M
Terminal value of the cash inflows: 114.47
MIRR of the project is given by the equation
50 (1 + MIRR)4 = 114.47
i.e., MIRR = 23.01%
Project N
Terminal value of the cash inflows: 115.41
MIRR of the project is given by the equation
50 ( 1+ MIRR)4 = 115.41
i.e., MIRR = 23.26%
12. The internal rate of return is the value of r in the equation
2,000 1,000 10,000 2,000

8000 = - + +
(1+r) (1+r)2 (1+r)3 (1+r)4
At r = 18%, the right hand side is equal to 8099
At r = 20%, the right hand side is equal to 7726
Thus the solving value of r is:
8,099 – 8,000
18% + x 2% = 18.5%
8,099 – 7,726
Un-recovered Investment Balance
Year Un-recovered Interest for the Cash flow at the Un-recovered
investment balance at year Ft-1 (1+r) end of the year CFt investment balance at
the beginning Ft-1 the end of the year Ft-1
(1+r) + CFt
1 -8000 -1480 2000 -7480
2 -7480 -1383.8 -1000 -9863.8
3 -9863.8 -1824.80 10000 -1688.60
4 -1688.60 -312.39 2000 0
13. Rs. in lakhs
Year 1 2 3 4 5 6 7 8 Sum Average
Investment 24.0 21.0 18.0 15.0 12.0 9.0 6.0 3.0 108 13.500
Depreciation 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 24.0 3.000
Income before 6.0 6.5 7.0 7.0 7.0 6.5 6.0 5.0 51.0 6.375
interest and tax
Interest 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 20.0 2.500
Income before tax 3.5 4.0 4.5 4.5 4.5 4.0 3.5 2.5 31.0 3.875
Tax - 1.0 2.5 2.5 2.5 2.2 1.9 1.4 14.0 1.750
Income after tax 3.5 3.0 2.0 2.0 2.0 1.8 1.6 1.1 17.0 2.125
Measures of Accounting Rate of Return
A. Average income after tax 2.125

= = 8.9%
Initial investment 24
B. Average income after tax 2.125

= = 15.7%
Average investment 13.5
C. Average income after tax but before interest 2.125 + 2.5

= = 19.3%
D. Average income after tax but before interest 2.125 + 2.5

= = 34.3%
E. Average income before interest and taxes 6.375

= = 26.6%
F. Average income before interest and taxes 6.375

= = 47.2%
G. Total income after tax but before

Depreciation – Initial investment 17.0 + 24.0 – 24.0
=
(Initial investment / 2) x Years (24 / 2) x 8
= 17.0 / 96.0 = 17.7%
Chapter 9 PROJECT CASH FLOWS
1.
(a) Project Cash Flows (Rs. in million)
Year 0 1 2 3 4 5 6 7
1. Plant & machinery (150)
2. Working capital (50)
3. Revenues 250 250 250 250 250 250 250
4. Costs (excluding de-

preciation & interest) 100 100 100 100 100 100 100
5. Depreciation 37.5 28.13 21.09 15.82 11.87 8.90 6.67
6. Profit before tax 112.5 121.87 128.91 134.18 138.13 141.1 143.33
7. Tax 33.75 36.56 38.67 40.25 41.44 42.33 43.0
8. Profit after tax 78.75 85.31 90.24 93.93 96.69 98.77 100.33
9. Net salvage value of

plant & machinery 48
10. Recovery of working 50

capital
11. Initial outlay (=1+2) (200)
12. Operating CF (= 8 + 5) 116.25 113.44 111.33 109.75 108.56 107.67 107.00
13. Terminal CF ( = 9 +10) 98
14. NCF (200) 116.25 113.44 111.33 109.75 108.56 107.67 205
(c) IRR (r) of the project can be obtained by solving the following equation for r
-200 + 116.25 x PVIF (r,1) + 113.44 x PVIF (r,2)

+ 111.33 x PVIF (r,3) + 109.75 x PVIF (r,4) + 108.56 x PVIF (r,5)
+107.67 x PVIF (r,6) + 205 x PVIF (r,7) = 0
Through a process of trial and error, we get r = 55.17%. The IRR of the project is
55.17%.
2. Post-tax Incremental Cash Flows (Rs. in million)
Year 0 1 2 3 4 5 6 7
1. Capital equipment (120)

2. Level of working capital 20 30 40 50 40 30 20
(ending)
3. Revenues 80 120 160 200 160 120 80
4. Raw material cost 24 36 48 60 48 36 24
5. Variable mfg cost. 8 12 16 20 16 12 8
6. Fixed operating & maint. 10 10 10 10 10 10 10
cost
7. Variable selling expenses 8 12 16 20 16 12 8
8. Incremental overheads 4 6 8 10 8 6 4
9. Loss of contribution 10 10 10 10 10 10 10
10.Bad debt loss 4
11. Depreciation 30 22.5 16.88 12.66 9.49 7.12 5.34
12. Profit before tax -14 11.5 35.12 57.34 42.51 26.88 6.66
13. Tax - 4.2 3.45 10.54 17.20 12.75 8.06 2.00
14. Profit after tax - 9.8 8.05 24.58 40.14 29.76 18.82 4.66
15. Net salvage value of
capital equipments 25
16. Recovery of working 16
capital
17. Initial investment (120)
18. Operating cash flow 20.2 30.55 41.46 52.80 39.25 25.94 14.00
(14 + 10+ 11)
19. ∆ Working capital 20 10 10 10 (10) (10) (10)
20. Terminal cash flow 41
21. Net cash flow (140) 10.20 20.55 31.46 62.80 49.25 35.94 55.00
(17+18-19+20)
(b) NPV of the net cash flow stream @ 15% per discount rate
= -140 + 10.20 x PVIF(15%,1) + 20.55 x PVIF (15%,2)

+ 31.46 x PVIF (15%,3) + 62.80 x PVIF (15%,4) + 49.25 x PVIF
(15%,5)
+ 35.94 x PVIF (15%,6) + 55 x PVIF (15%,7)
= Rs.1.70 million
3.
(a) A. Initial outlay (Time 0)
i. Cost of new machine Rs. 3,000,000

ii. Salvage value of old machine 900,000
iii Incremental working capital requirement 500,000
iv. Total net investment (=i – ii + iii) 2,600,000
B. Operating cash flow (years 1 through 5)
Year 1 2 3 4 5
i. Post-tax savings in
manufacturing costs 455,000 455,000 455,000 455,000 455,000
ii. Incremental
depreciation 550,000 412,500 309,375 232,031 174,023
iii. Tax shield on

incremental dep. 165,000 123,750 92,813 69,609 52,207
iv. Operating cash

flow ( i + iii) 620,000 578,750 547,813 524,609 507,207
C. Terminal cash flow (year 5)
i. Salvage value of new machine Rs. 1,500,000

ii. Salvage value of old machine 200,000
iii. Recovery of incremental working capital 500,000
iv. Terminal cash flow ( i – ii + iii) 1,800,000
D. Net cash flows associated with the replacement project (in Rs)
Year 0 1 2 3 4 5
NCF (2,600,000) 620000 578750 547813 524609 307207
(b) NPV of the replacement project

= - 2600000 + 620000 x PVIF (14%,1)
+ 578750 x PVIF (14%,2)
+ 547813 x PVIF (14%,3)
+ 524609 x PVIF (14%,4)
+ 2307207 x PVIF (14%,5)
= Rs.267849
4. Tax shield (savings) on depreciation (in Rs)
Depreciation Tax shield PV of tax shield

Year charge (DC) =0.4 x DC @ 15% p.a.
1 25000 10000 8696

2 18750 7500 5671
3 14063 5625 3699
4 10547 4219 2412
5 7910 3164 1573
--------
22051
Present value of the tax savings on account of depreciation = Rs.22051
5. A. Initial outlay (at time 0)
i. Cost of new machine Rs. 400,000

ii. Salvage value of the old machine 90,000
iii. Net investment 310,000
B. Operating cash flow (years 1 through 5)
Year 1 2 3 4 5
i. Depreciation
of old machine 18000 14400 11520 9216 7373
ii. Depreciation
of new machine 100000 75000 56250 42188 31641
iii. Incremental depre-

ciation ( ii – i) 82000 60600 44730 32972 24268
iv. Tax savings on inc-

remental depreciation
( 0.35 x (iii)) 28700 21210 15656 11540 8494
v. Operating cash flow 28700 21210 15656 11540 8494
C. Terminal cash flow (year 5)
i. Salvage value of new machine Rs. 25000

ii. Salvage value of old machine 10000
iii. Incremental salvage value of new
machine = Terminal cash flow 15000
D. Net cash flows associated with the replacement proposal.
Year 0 1 2 3 4 5
NCF (310000) 28700 21210 15656 11540 23494
6. Net Cash Flows Relating to Equity (Rs. in million)

Particulars Year
0 1 2 3 4 5 6
1. Equity funds (100)
2. Revenues 500 500 500 500 500 500
3. Operating costs 320 320 320 320 320 320
4. Depreciation 83.33 55.56 37.04 24.69 16.46 10.97
5. Interest on working capital 18.00 18.00 18.00 18.00 18.00 18.00
advance
6. Interest on term loan 30.00 28.50 22.50 16.50 10.50 4.50
7. Profit before tax 48.67 77.94 102.46 120.81 135.04 146.53
8. Tax 24.335 38.97 51.23 60.405 67.52 73.265
9. Profit after tax 24.335 38.97 51.23 60.405 67.52 73.265
10. Preference dividend
11. Net salvage value of fixed assets 200
12. Net salvage value of current - 40 40 40 40 40
assets
13. Repayment of term-loans
14. Redemption of preference capital
15. Repayment of short-term bank 100
borrowings
16. Retirement of trade creditors 50
17. Initial investment (1) (100)
18. Operating cash flows (9-10+4) 107.665 94.53 88.27 85.095 83.98 84.235
19. Liquidation and retirement cash 107.665 54.53 48.27 45.095 43.98 90
flows (11+12-13-14-15-16)
20. Net cash flows (17+18+19) (100) 107.665 54.53 48.27 45.095 43.98 174.235
Net Cash Flows Relating to Long-term Funds (Rs. in million)

Particulars Year
0 1 2 3 4 5 6
1. Fixed assets (250)
2. Working capital margin (50)
3. Revenues 500 500 500 500 500 500
4. Operating costs 320 320 320 320 320 320
5. Depreciation 83.33 55.56 37.04 24.69 16.46 10.97
advance
9. Tax @ 50% 24.335 38.97 51.23 60.405 67.52 73.265
10. Profit after tax 24.335 38.97 51.23 60.405 67.52 73.265
11. Net salvage value of fixed assets 80
12. Net recovery of working capital 50
margin
13. Initial investment (1+2) (300)
14. Operating cash inflow (9+5+7 122.665 108.78 99.52 93.345 89.23 86.845
(1-T) )
15. Terminal cash flow (11+12) 130.00
16. Net cash flow (13+14+15) (300) 122.665 108.78 99.52 93.345 89.23 216.485
Cash Flows Relating to Total Funds (Rs. in million)

Year
0 1 2 3 4 5 6
1. Total funds (450)
2. Revenues 500 500 500 500 500 500
3. Operating costs 320 320 320 320 320 320
4. Depreciation 83.33 55.56 37.04 24.69 16.46 10.97
advance
8. Tax 24.34 38.97 51.23 60.41 67.52 73.265
9. Profit after tax 24.34 38.97 51.23 60.41 67.52 73.265
10. Net salvalue of fixed assets 80
11. Net salvage value of current assets 200
12. Initial investment (1) (450)
13. Operating cash inflow 9+4+6 (1-t) 131.67 117.78 108.52 102.35 98.23 95.485
+ 5(1-t)
14. Terminal cash flow (10+11) 280
15. Net cash flow (12+13+14) (450) 131.67 117.78 108.52 102.35 98.23 375.485
Chapter 11 RISK ANALYSIS OF SINGLE INVESTMENTS
1.
(a) NPV of the project = -250 + 50 x PVIFA (13%,10)
= Rs.21.31 million
(b) NPVs under alternative scenarios:

(Rs. in million)
Pessimistic Expected Optimistic
Investment 300 250 200

Sales 150 200 275
Variable costs 97.5 120 154
Fixed costs 30 20 15
Depreciation 30 25 20
Pretax profit - 7.5 35 86
Tax @ 28.57% - 2.14 10 24.57
Profit after tax - 5.36 25 61.43
Net cash flow 24.64 50 81.43
Cost of capital 14% 13% 12%
NPV - 171.47 21.31 260.10
Assumptions: (1) The useful life is assumed to be 10 years under all three
scenarios. It is also assumed that the salvage value of the
investment after ten years is zero.
(2) The investment is assumed to be depreciated at 10% per annum; and

it is also assumed that this method and rate of depreciation are
acceptable to the IT (income tax) authorities.
(3) The tax rate has been calculated from the given table i.e. 10 / 35 x
100 = 28.57%.
(4) It is assumed that only loss on this project can be offset against the
taxable profit on other projects of the company; and thus the
company can claim a tax shield on the loss in the same year.
(c) Accounting break even point (under ‘expected’ scenario)

Fixed costs + depreciation = Rs. 45 million
Contribution margin ratio = 60 / 200 = 0.3
Break even level of sales = 45 / 0.3 = Rs.150 million
Financial break even point (under ‘expected’ scenario)
i. Annual net cash flow = 0.7143 [ 0.3 x sales – 45 ] + 25

= 0.2143 sales – 7.14
ii. PV (net cash flows) = [0.2143 sales – 7.14 ] x PVIFA (13%,10)

= 1.1628 sales – 38.74
iii. Initial investment = 200
iv. Financial break even level of sales = 238.74 / 1.1628 = Rs.205.31 million
2.
(a) Sensitivity of NPV with respect to quantity manufactured and sold: (in Rs)
Initial investment 30000 30000 30000

Sale revenue 24000 42000 54000
Variable costs 16000 28000 36000
Fixed costs 3000 3000 3000
Profit before tax 3000 9000 13000
Tax 1500 4500 6500
Profit after tax 1500 4500 6500
Net cash flow 3500 6500 8500
NPV at a cost of
capital of 10% p.a
and useful life of
5 years -16732 - 5360 2222
(b) Sensitivity of NPV with respect to variations in unit price.


Sale revenue 28000 42000 70000
Fixed costs 3000 3000 3000
Profit before tax -5000 9000 37000
Tax -2500 4500 18500
Profit after tax -2500 4500 18500
Net cash flow - 500 6500 20500
NPV - 31895 (-) 5360 47711
(c) Sensitivity of NPV with respect to variations in unit variable cost.


Sale revenue 42000 42000 42000
Fixed costs 3000 3000 3000
Profit before tax -11000 9000 16000
Tax -5500 4500 8000
Profit after tax -5500 4500 8000
Net cash flow -3500 6500 10000
NPV -43268 - 5360 7908
(d) Accounting break-even point

i. Fixed costs + depreciation = Rs.5000
ii. Contribution margin ratio = 10 / 30 = 0.3333
iii. Break-even level of sales = 5000 / 0.3333 = Rs.15000
Financial break-even point
i. Annual cash flow = 0.5 x (0.3333 Sales – 5000) = 2000
ii. PV of annual cash flow = (i) x PVIFA (10%,5)
= 0.6318 sales – 1896
iii. Initial investment = 30000
iv. Break-even level of sales = 31896 / 0.6318 = Rs.50484
2. Define At as the random variable denoting net cash flow in year t.
A1 = 4 x 0.4 + 5 x 0.5 + 6 x 0.1

= 4.7
A2 = 5 x 0.4 + 6 x 0.4 + 7 x 0.2

= 5.8
A3 = 3 x 0.3 + 4 x 0.5 + 5 x 0.2

= 3.9
NPV = 4.7 / 1.1 +5.8 / (1.1)2 + 3.9 / (1.1)3 – 10

= Rs.2.00 million
σ12 = 0.41
σ22 = 0.56
σ32 = 0.49
σ12 σ22 σ32

σ2 NPV = + +
(1.1)2 (1.1)4 (1.1)6
= 1.00
σ (NPV) = Rs.1.00 million
3. Expected NPV
4 At
= ∑ - 25,000
t=1 (1.08)t
= 12,000/(1.08) + 10,000 / (1.08)2 + 9,000 / (1.08)3

+ 8,000 / (1.08)4 – 25,000
= [ 12,000 x .926 + 10,000 x .857 + 9,000 x .794 + 8,000 x .735]

- 25,000
= 7,708
Standard deviation of NPV
4 σt
∑
t=1 (1.08)t
= 5,000 / (1.08) + 6,000 / (1.08)2 + 5,000 / (1,08)3 + 6,000 / (1.08)4

= 5,000 x .926 + 6,000 x .857 + 5000 x .794 + 6,000 x .735
= 18,152
4. Expected NPV
4 At
= ∑ - 25,000 …. (1)
t
t=1 (1.06)
A1 = 2,000 x 0.2 + 3,000 x 0.5 + 4,000 x 0.3
= 3,100
A2 = 3,000 x 0.4 + 4,000 x 0.3 + 5,000 x 0.3

= 3,900
A3 = 4,000 x 0.3 + 5,000 x 0.5 + 6,000 x 0.2

= 4,900
A4 = 2,000 x 0.2 + 3,000 x 0.4 + 4,000 x 0.4

= 3,200
Substituting these values in (1) we get
Expected NPV = NPV
= 3,100 / (1.06)+ 3,900 / (1.06)2 + 4,900 / (1.06)3 + 3,200 / (1,06)4

- 10,000 = Rs.3,044
The variance of NPV is given by the expression

4 σ2t
σ2 (NPV) = ∑ …….. (2)
t=1 (1.06)2t
σ12 = [(2,000 – 3,100)2 x 0.2 + (3,000 – 3,100)2 x 0.5

+ (4,000 – 3,100)2 x 0.3]
= 490,000
σ22 = [(3,000 – 3,900)2 x 0.4 + (4,000 – 3,900)2 x 0.3

+ (5,000 – 3900)2 x 0.3]
= 690,000
σ32 = [(4,000 – 4,900)2 x 0.3 + (5,000 – 4,900)2 x 0.5

+ (6,000 – 4,900)2 x 0.2]
= 490,000
σ42 = [(2,000 – 3,200)2 x 0.2 + (3,000 – 3,200)2 x 0.4

+ (4,000 – 3200)2 x 0.4]
= 560,000
Substituting these values in (2) we get

490,000 / (1.06)2 + 690,000 / (1.06)4
+ 490,000 / (1.06)6 + 560,000 / (1.08)8
[ 490,000 x 0.890 + 690,000 x 0.792
+ 490,000 x 0.705 + 560,000 x 0.627 ]
= 1,679,150
σ NPV = 1,679,150 = Rs.1,296
NPV – NPV 0 - NPV

Prob (NPV < 0) = Prob. <
σ NPV σ NPV
0 – 3044
= Prob Z<
1296
= Prob (Z < -2.35)
The required probability is given by the shaded area in the following normal curve.
P (Z < - 2.35) = 0.5 – P (-2.35 < Z < 0)

= 0.5 – P (0 < Z < 2.35)
= 0.5 – 0.4906
= 0.0094
So the probability of NPV being negative is 0.0094
Prob (P1 > 1.2) Prob (PV / I > 1.2)

Prob (NPV / I > 0.2)
Prob. (NPV > 0.2 x 10,000)
Prob (NPV > 2,000)
Prob (NPV >2,000)= Prob (Z > 2,000- 3,044 / 1,296)

Prob (Z > - 0.81)
The required probability is given by the shaded area of the following normal
curve:
P(Z > - 0.81) = 0.5 + P(-0.81 < Z < 0)
= 0.5 + P(0 < Z < 0.81)
= 0.5 + 0.2910
= 0.7910
So the probability of P1 > 1.2 as 0.7910
5. Given values of variables other than Q, P and V, the net present value model of Bidhan
Corporation can be expressed as:
5
∑ [Q(P – V) – 3,000 – 2,000] (0.5)+ 2,000 0
t=1
NPV = ---------------------------------------------------------- + ------- - 30,000
(1.1)t (1.1)5
5
∑ 0.5 Q (P – V) – 500
t=1 ------------------------------------ - 30,000
(1.1)t
= [ 0.5Q (P – V) – 500] x PVIFA (10,5) – 30,000
= [0.5Q (P – V) – 500] x 3.791 – 30,000
= 1.8955Q (P – V) – 31,895.5
Exhibit 1 presents the correspondence between the values of exogenous variables and the
two digit random number. Exhibit 2 shows the results of the simulation.
Exhibit 1
Correspondence between values of exogenous variables and two digit random numbers
QUANTITY PRICE VARIABLE COST
Two Two digit Two
Cumulative digit Cumulative random Cumul digit
Value Prob Prob. random Value Prob Prob. numbers Value Prob ative random
numbers Prob. numbers
800 0.10 0.10 00 to 09 20 0.40 0.40 00 to 39 15 0.30 0.30 00 to 29
1,000 0.10 0.20 10 to 19 30 0.40 0.80 40 to 79 20 0.50 0.80 30 to 79
1,200 0.20 0.40 20 to 39 40 0.10 0.90 80 to 89 40 0.20 1.00 80 to 99
1,400 0.30 0.70 40 to 69 50 0.10 1.00 90 to 99
1,600 0.20 0.90 70 to 89
1,800 0.10 1.00 90 to 99
Exhibit 2
Simulation Results
QUANTITY (Q) PRICE (P) VARIABLE COST (V) NPV
Run Random Corres- Random Corres- Random Corres- 1.8955 Q(P-V)-31,895.5
Number ponding Number ponding Number ponding
Value value value
1 03 800 38 20 17 15 -24,314
2 32 1,200 69 30 24 15 2,224
3 61 1,400 30 20 03 15 -18,627
4 48 1,400 60 30 83 40 -58,433
5 32 1,200 19 20 11 15 -20,523
6 31 1,200 88 40 30 20 13,597
7 22 1,200 78 30 41 20 -9,150
8 46 1,400 11 20 52 20 -31,896
9 57 1,400 20 20 15 15 -18,627
Value value value
10 92 1,800 77 30 38 20 2,224
11 25 1,200 65 30 36 20 -9,150
12 64 1,400 04 20 83 40 -84,970
13 14 1,000 51 30 72 20 -12,941
14 05 800 39 20 81 40 -62,224
15 07 800 90 50 40 20 13,597
16 34 1,200 63 30 67 20 -9,150
17 79 1,600 91 50 99 40 -1,568
18 55 1,400 54 30 64 20 -5,359
19 57 1,400 12 20 19 15 -18,627
20 53 1,400 78 30 22 15 7,910
21 36 1,200 79 30 96 40 -54,642
22 32 1,200 22 20 75 20 -31,896
23 49 1,400 93 50 88 40 -5,359
24 21 1,200 84 40 35 20 13,597
25 08 .800 70 30 27 15 -9,150
26 85 1,600 63 30 69 20 -1,568
27 61 1,400 68 30 16 15 7,910
28 25 1,200 81 40 39 20 13,597
29 51 1,400 76 30 38 20 -5,359
30 32 1,200 47 30 46 20 -9,150
31 52 1,400 61 30 58 20 -5,359
32 76 1,600 18 20 41 20 -31,896
33 43 1,400 04 20 49 20 -31,896
34 70 1,600 11 20 59 20 -31,896
35 67 1,400 35 20 26 15 -18,627
36 26 1,200 63 30 22 15 2,224
Value value value
37 89 1,600 86 40 59 20 28,761
38 94 1,800 00 20 25 15 -14,836
39 09 .800 15 20 29 15 -24,314
40 44 1,400 84 40 21 15 34,447
41 98 1,800 23 20 79 20 -31,896
42 10 1,000 53 30 77 20 -12,941
43 38 1,200 44 30 31 20 -9,150
44 83 1,600 30 20 10 15 -16,732
45 54 1,400 71 30 52 20 -5,359
46 16 1,000 70 30 19 15 -3,463
47 20 1,200 65 30 87 40 -54,642
48 61 1,400 61 30 70 20 -5,359
49 82 1,600 48 30 97 40 -62,224
50 90 1,800 50 30 43 20 2,224
Expected NPV = NPV

50
= 1/ 50 ∑ NPVi
i=1
= 1/50 (-7,20,961)
= 14,419
50
Variance of NPV = 1/50 ∑ (NPVi – NPV)2
i=1
= 1/50 [27,474.047 x 106]

= 549.481 x 106
Standard deviation of NPV = 549.481 x 106

= 23,441
6. To carry out a sensitivity analysis, we have to define the range and the most likely values of
the variables in the NPV Model. These values are defined below
Variable Range Most likely value

I Rs.30,000 – Rs.30,000 Rs.30,000
k 10% - 10% 10%
F Rs.3,000 – Rs.3,000 Rs.3,000
D Rs.2,000 – Rs.2,000 Rs.2,000
T 0.5 – 0.5 0.5
N 5–5 5
S 0–0 0
Q Can assume any one of the values - 1,400*
800, 1,000, 1,200, 1,400, 1,600 and 1,800
P Can assume any of the values 20, 30, 30**
40 and 50
V Can assume any one of the values 20*
15,20 and 40
----------------------------------------------------------------------------------------
* The most likely values in the case of Q, P and V are the values that
have the highest probability associated with them
** In the case of price, 20 and 30 have the same probability of

occurrence viz., 0.4. We have chosen 30 as the most likely value
because the expected value of the distribution is closer to 30
Sensitivity Analysis with Reference to Q
The relationship between Q and NPV given the most likely values of other variables is
given by
5 [Q (30-20) – 3,000 – 2,000] x 0.5 + 2,000 0
NPV = ∑ + - 30,000
t 5
t=1 (1.1) (1.1)
5 5Q - 500
= ∑ - 30,000
t
t=1 (1.1)
The net present values for various values of Q are given in the following table:
Q 800 1,000 1,200 1,400 1,600 1,800

NPV -16,732 -12,941 -9,150 -5,359 -1,568 2,224
Sensitivity analysis with reference to P

The relationship between P and NPV, given the most likely values of other variables is
defined as follows:
5 [1,400 (P-20) – 3,000 – 2,000] x 0.5 + 2,000 0

NPV = ∑ + - 30,000
t=1 (1.1)t (1.1)5
5 700 P – 14,500
= ∑ - 30,000
t=1 (1.1)t
The net present values for various values of P are given below :
P (Rs) 20 30 40 50
NPV(Rs) -31,896 -5,359 21,179 47,716
8. NPV -5 0 5 10 15 20
(Rs.in lakhs)
PI 0.9 1.00 1.10 1.20 1.30 1.40
Prob. 0.02 0.03 0.10 0.40 0.30 0.15
6
Expected PI = PI = ∑ (PI)j P j
j=1
= 1.24
6
Standard deviation = ∑ (PIj - PI) 2 P j
o f P1 j=1
= √ .01156
= .1075
The standard deviation of P1 is .1075 for the given investment with an expected PI of
1.24. The maximum standard deviation of PI acceptable to the company for an investment with
an expected PI of 1.25 is 0.30.
Since the risk associated with the investment is much less than the maximum
risk acceptable to the company for the given level of expected PI, the company
should accept the investment.
9. Investment A
Outlay : Rs.10,000
Net cash flow : Rs.3,000 for 6 years
Required rate of return : 12%
NPV(A) = 3,000 x PVIFA (12%, 6 years) – 10,000

= 3,000 x 4.11 – 10,000 = Rs.2,333
Investment B
Outlay : Rs.30,000
Net cash flow : Rs.11,000 for 5 years
Required rate of return : 14%
NPV(B) = 11,000 x PVIFA (14%, 5 years) – 30,000
= Rs.7763
10. The NPVs of the two projects calculated at their risk adjusted discount rates are as
follows:
6 3,000
Project A: NPV = ∑ - 10,000 = Rs.2,333
t
t=1 (1.12)
5 11,000
Project B: NPV = ∑ - 30,000 = Rs.7,763
t
t=1 (1.14)
PI and IRR for the two projects are as follows:

Project A B
PI 1.23 1.26
IRR 20% 24.3%
B is superior to A in terms of NPV, PI, and IRR. Hence the company must choose B.
Chapter 13 SPECIAL DECISION SITUATIONS
1. PV Cost
UAE =
PVIFAr,n
Cost of plastic emulsion painting = Rs.3,00,000 Life = 7 years

Cost of distemper painting = Rs. 1,80,000 Life = 3 years
Discount rate = 10%
UAE of plastic emulsion painting = Rs.3,00,000 / 4.868 = Rs.61,627
UAE of distemper painting = Rs.1,80,000 / 2.487 = Rs.72,376
Since plastic emulsion painting has a lower UAE, it is preferable.
2. Present value of the operating costs :

3,00,000 3,60,000 4,00,000 4,50,000 5,00,000
= + + + +
1.13 (1.13)2 (1.13)3 (1.13)4 (1.13)5
= Rs.1,372,013
Present value of salvage value = 3,00,000 / (1.13)5 = Rs.162,828
Present value of costs of internal transportation = 1,500,000 –1,372,013
system – 162,828 = Rs.27,09,185
UAE of the internal transportation system = 27,09,185 / 3.517 = Rs.7,70,311
3. Cost of standard overhaul = Rs.500,000

Cost of less costly overhaul = Rs.200,000
Cost of capital = 14%
UAE of standard overhaul = 500,000 / 3.889 = Rs.128,568
UAE of less costly overhaul = 200,000 / 1.647 = Rs.121,433
Since the less costly overhaul has a lower UAE, it is the preferred alternative
4. The details for the two alternatives are shown below :

Gunning plow Counter plow
1. Initial outlay Rs.2,500,000 Rs.1,500,000

2. Economic life 12 years 9 years
3. Annual operating and maintenance costs Rs.250,000 Rs.320,000
4. Present value of the stream of operating Rs.1,548,500 Rs.1,704,960
and maintenance costs at 12% discount rate
5. Salvage value Rs.800,000 Rs.500,000
6. Present value of salvage value Rs.205,600 Rs.180,500
7. Present value of total costs (1+4-6) Rs.3,842,900 Rs.3,024,460
8. UAE of 7 Rs.3,842,900 Rs.3,024,460
PVIFA (12%,12) PVIFA (12%,9)
= 3,842,900 = 3,024,460
6.194 5.328
= Rs.620,423 = Rs.567,654
The Counter plow is a cheaper alternative
5. The current value of different timing options is given below :
Time Net Future Value Current Value

Rs. in million Rs. in million
0 10 10
1 15 13.395
2 19 15.143
3 23 16.376
4 26 16.536
The optimal timing of the project is year 4.
6. Calculation of UAE (OM) for Various Replacement Periods (Rupees)

Time Operating Post-tax PVIF Present Cumulative PVIFA UAE
(t) and operating & (12%,t) value of present (12%,t) (OM)
maintenance maintenance (3) value
costs costs
(1) (2) (3) (4) (5) (6) (7) (8)
1 20,000 12,000 0.893 10,716 10,716 0.893 12,000
2 25,000 15,000 0.797 11,955 22,671 1.690 13,415
3 35,000 21,000 0.712 14,952 37,623 2.402 15,663
4 50,000 30,000 0.636 19,080 56,703 3.037 18,671
5 70,000 42,000 0.567 23,814 80,517 3.605 22,335
Calculation of UAE (IO) for Various Replacement Periods

Time (t) Investment Outlay Rs. PVIFA (12%, t) UAE of investment outlay Rs.
1 80,000 0.893 89,586
2 80,000 1.690 47,337
3 80,000 2.402 33,306
4 80,000 3.037 26,342
5 80,000 3.605 22,191
Calculation of UAE (DTS) for Various Replacement Periods

Time Depreciation Depreciation PVIF PV of Cumulative PVIFA UAE of
(t) charge R.s. tax shield (12%, t) depreciation present (12%, t) depreciation
tax shield Rs.. value Rs.. tax shield Rs.
(1) (2) (3) (4) (5) (6) (7) (8)
1 20,000 8,000 0.893 7,144 7,144 0.893 8,000
2 15,000 6,000 0.797 4,782 11,926 1.690 7,057
3 11,250 4,500 0.712 3,204 15,130 2.402 6,299
4 8,438 3,375 0.636 2,147 17,277 3.037 5,689
5 6,328 2,531 0.567 1,435 18,712 3.605 5,191
Calculation of UAE (SV) for Various Replacement Periods

Time Salvage PVIF Present value of PVIFA UAE of salvage
value Rs. (12%, t) salvage value Rs. (12%, t) value Rs. (4) / (5)
(1) (2) (3) (4) (5) (6)
1 60,000 0.893 53,580 0.893 60,000
2 45,000 0.797 35,865 1.690 21,222
3 32,000 0.712 22,784 2.402 9,485
4 22,000 0.636 13,992 3.037 4,607
5 15,000 0.567 8,505 3.605 2,359
Summary of Information Required to Determine the Economic Life

Replacement UAE UAE (IO) UAE UAE (SV) UAE UAE
period (OM) Rs. Rs. (DTS) Rs. Rs. (CC) Rs. (TC) Rs.
(1) (2) (3) (4) (5) (6) (7)
1 12,000 89,586 8,000 60,000 21,586 33,586
2 13,415 47,337 7,057 21,222 19,058 32,473
3 15,663 33,306 6,299 9,485 17,522 33,185
4 18,671 26,342 5,689 4,607 16,046 34,717
5 22,335 22,191 5,190 2,359 14,642 36,977
OM - Operating and Maintenance Costs

IO - Investment Outlay
DTS - Depreciation Tax Shield
SV - Salvage Value
CC - Capital Cost
TC - Total Cost
UAE (CC) = UAE (IO) – [UAE (DTS) + UAE (SV)]
UAE (TC) = UAE (OM) + UAE (CC)
7. Calculation of UAE (OM) for Various Replacement periods

Time O&M costs Post-tax PVIF PV of post- Cumulative PVIFA UAE of
Rs. O&M costs (12%,t) tax O&M present (12%, t) O&M
Rs. costs Rs. value Rs. costs Rs.
(1) (2) (3) (4) (5) (6) (7) (8)
1 800,000 560,000 0.893 500,080 500,080 0.893 560,000
2 1,000,000 700,000 0.797 557,900 1,057,980 1.690 626,024
3 1,300,000 910,000 0.712 647,920 1,705,9000 2.402 710,200
4 1,900,000 1,330,000 0.636 845,880 2,551,780 3.037 840,230
5 2,800,000 1,960,000 0.567 1,111,320 3,663,100 3.605 1,016,117
Calculation of UAE (IO) for Various Replacement Periods

Time Investment outlay Rs. PVIFA (12%, t) UAE of investment outlay Rs.
1 4,000,000 0.893 4,479,283
2 4,000,000 1.690 2,366,864
3 4,000,000 2.402 1,665,279
4 4,000,000 3.037 1,317,089
5 4,000,000 3.605 1,109,570
Calculation of UAE (DTS) for Various Replacement Periods

Time Depreciation Depreciaton PVIF PV of Cumulative PVIFA UAE of
(t) charge Rs. tax shield (12%, t) depreciation present (12%, t) depreciation
Rs. tax shield Rs. value Rs. tax shield Rs.
1 1,000,000 300,000 0.893 267,940 267,900 0.893 300,000
2 750,000 225,000 0.797 179,325 447,225 1.690 264,630
3 562,500 168,750 0.712 120,150 567,375 2.402 236,209
4 421,875 126,563 0.636 80,494 647,869 3.037 213,325
5 316,406 94,922 0.567 53,821 701,690 3.605 194,643
Calculation of UAE (SV) for Various Replacement Periods
Time Salvage PVIF Present value of PVIFA UAE of salvage
value Rs. (12%, t) salvage value Rs. (12%, t) value Rs. (4)/ (5)
(1) (2) (3) (4) (5) (6)
1 2,800,000 0.893 267,900 0.893 2,800,000
2 2,000,000 0.797 1,594,000 1.690 943,195
3 1,400,000 0.712 996,80 2.402 414,988
4 1,000,000 0.636 636,000 3.037 209,417
5 800,000 0.567 453,600 3.605 125,825
Summary of Information Required Determining the Economic Life

Replacement UAE UAE (IO) UAE UAE (SV) UAE (CC) UAE (TC)
period (OM) Rs. (DTS)
Rs. Rs. Rs. Rs. Rs.
1 560,000 4,479,283 300,000 2,800,000 (-)1,379,283 -819,283
2 626,024 2,366,864 264,630 943,195 1,159,039 1,785,063
3 710,200 1,665,279 236,209 414,988 1,014,082 1,724,282
4 840,230 1,317,089 213,325 209,417 894,347 1,734,577
5 1,016,117 1,109,570 194,643 125,825 789,102 1,805,219
The economic life of the well-drilling machine is 3 years
8. Adjusted cost of capital as per Modigliani – Miller formula:

r* = r (1 – TL)
r* = 0.16 (1 – 0.5 x 0.6)
= 0.16 x 0.7 = 0.112
Adjusted cost of capital as per Miles – Ezzell formula:
1+r
r* = r – LrDT
1 + rD
1 + 0.16
= 0.16 – 0.6 x 0.15 x 0.5 x
1 + 0.15
= 0.115
9.
a. Base case NPV = -12,000,000 + 3,000,000 x PVIFA (20%, b)
= -12,000,000 + 3,000,000 x 3,326
= - Rs.2,022,000
b. Adjusted NPV = Base case NPV – Issue cost + Present value of tax shield.
Term loan = Rs.8 million Equity finance = Rs.4 million
Issue cost of equity = 12%
Rs.4,000,000
Equity to be issued = = Rs.4,545,455
0.88
Cost of equity issue = Rs.545,455
Computation of Tax Shield Associated with Debt Finance
Year (t) Debt outstanding Interest Tax shield Present value of
at the beginning tax shield
Rs. Rs. Rs. Rs.
1 8,000,000 1,440,000 432,000 366,102
2 8,000,000 1,440,000 432,000 310,256
3 7,000,000 1,260,000 378,000 230,062
4 6,000,000 1,080,000 324,000 167,116
5 5,000,000 900,000 270,000 118,019
6 4,000,000 720,000 216,000 80,013
1,271,568
Adjusted NPV = - Rs.2,022,000 – Rs.545,455 + Rs.1,271,568

= - Rs.1,295,887
Adjusted NPV if issue cost alone is considered = Rs.2,567,455
Present Value of tax shield of debt finance = Rs.1,271,568
10.
a. Base Case NPV = - 8,000,000 + 2,000,000 x PVIFA (18%, 6)
= - 8,000,000 + 2,000,000 x 3,498
= - Rs.1,004,000
b. Adjusted NPV = Base case NPV – Issue cost + Present value of tax shield.
Term loan = Rs.5 million
Equity finance = Rs.3 million
Issue cost of equity = 10%
Rs.3,000,000
Hence, Equity to be issued = = Rs.3,333,333
0.90
Cost of equity issue = Rs.333,333
Computation of Tax Shield Associated with Debt Finance

Year Debt outstanding at the Interest Tax shield Present value of tax
beginning shield
1 Rs.5,000,000 Rs.750,000 Rs.300,000 Rs.260,869
2 5,000,000 750,000 300,000 226,843
3 4,000,000 600,000 240,000 157,804
4 3,00,000 450,000 180,000 102,916
5 2,000,000 300,000 120,000 59,66
6 1,000,000 150,000 60,000 25,940
843,033
Adjusted NPV = - 1004000 – 333333 + 834033 = - Rs.503,300

Adjusted NPV if issue cost of external
equity alone is adjusted for = - Rs.1,004000 – Rs.333333
= Rs.1337333
c. Present value of tax shield of debt finance = Rs.834,033
11. Adjusted cost of capital as per Modigliani – Miller formula:

r* = r (1 – TL)
r* = 0.19 x (1 – 0.5 x 0.5) = 0.1425 = 14.25%
Adjusted cost of capital as per Miles and Ezzell formula:

1+r
r* = r – LrDT
1 + rD
1 + 0.19
= 0.19 – 0.5 x 0.16 x 0.5 x
1 + 0.16
= 0.149 = 14.9%
12. S0 = Rs.46 , rh = 11 per cent , rf = 6 per cent

Hence the forecasted spot rates are :
Year Forecasted spot exchange rate
1 Rs.46 (1.11 / 1.06)1 = Rs.48.17
2 Rs.46 (1.11 / 1.06)2 = Rs.50.44
3 Rs.46 (1.11 / 1.06)3 = Rs.52.82
4 Rs.46 (1.11 / 1.06)4 = Rs.55.31
5 Rs.46 (1.11 / 1.06)5 = Rs.57.92
The expected rupee cash flows for the project
Year Cash flow in dollars Expected exchange Cash flow in rupees

(million) rate (million)
0 -200 46 -9200
1 50 48.17 2408.5
2 70 50.44 3530.8
3 90 52.82 4753.8
4 105 55.31 5807.6
5 80 57.92 4633.6
Given a rupee discount rate of 20 per cent, the NPV in rupees is :

2408.5 3530.8 4753.8
NPV = -9200 + + +
(1.18)2 (1.18)3 (1.18)4
5807.6 4633.6
+ +
(1.18)5 (1.18)6
= Rs.3406.2 million
The dollar NPV is :

3406.2 / 46 = 74.05 million dollars
Chapter 14 SOCIAL COST BENEFIT ANALYSIS
1. Social Costs and Benefits

Nature Economic Explanation
value (Rs
in million)
Costs
1. Construction cost One- 400
shot
2. Maintenance cost Annual 3
Benefits
3. Savings in the operation Annual 40
cost of existing ships
4. Increase in consumer Annual 3.6 The number of passenger hours
satisfaction saved will be : (75,000 x 2 +
50,000 + 50,000 x 2) = 600000.
Multiplying this by Rs.6 gives
Rs.3.6 million
The IRR of the stream of social costs and benefits is the value of r in the
equation
50 40 + 3.6 – 3.0 50 40.6
400 = Σ = Σ
t=1 (1+r)t t=1 (1+r)t
The solving value r is about 10.1%
2. Social Costs and Benefits

Costs
Decrease in customer satisfaction as reflected Rs.266,667
in the opportunity cost of the extra time taken
by bus journey
800 x (2/3) x 250 x Rs.2
Benefits
1. Resale value of the diesel train (one time) Rs.240,000
2. Avoidance of annual cash loss Rs.400,000
Fare collection = 1000 x 250 x Rs.4
= Rs.1,000,000
Cash operating expenses = Rs.1,400,000
3. The social costs and benefits of the project are estimated below: (Rs. in million)
Costs & Benefits Time Economic Explanation
value
1. Construction cost 0 24
2. Land development cost 0 150
3. Maintenance cost 1-40 1
4. Labour cost 0 40 This includes the cost of
transport and rehabilitation
5. Labour cost 1-40 12 The shadow price of labour
equals what others are willing
to pay.
6. Decrease in the value of the timber 2-40 4
output
Benefits
7. Savings in the cost of shipping the 1-40 0.5
agriculture produce
8. Income from cash crops 1-5 10
9. Income from the main crop 6-40 50
10. Increase in the value of timber output 1 20
Assuming that the life of the road is 40 years, the NPV of the stream of social costs and benefits at
a discount rate of 10 percent is:
40 1 + 12 40 4
NPV = - 24 - 150 - 40 - Σ - Σ
t=1 (1.1)t t=2 (1.1)t
40 0.5 5 10 40 50 20
+ Σ + Σ + Σ +
t=1 (1.1)t t=1 (1.1)t t=6 (1.1)t (1.1)1
= - Rs.9.93 million
4. Table 1
Social Costs Associated with the Initial Outlay Rs. in million
Item Financial Basis of Tradeable value T L R
cost conversion ab initio
Land 0.30 SCF = 1/1.5 0.20
Buildings 12.0 T=0.50, L=0.25 6.0 3.0 3.0
R=0.25
Imported equipment 15.0 CIF value 9.0
Indigeneous equipment 80.0 CIF value 60.0
Transport 2.0 T=0.65, L=0.25 1.3 0.5 0.2
R=0.10
Engineering and know-how 6.0 SCF=1.5 9.0
fees
Pre-operative expenses 6.0 SCF=1.0 6.0
Bank charges 3.7 SCF=0.02 0.074
Working capital 25.0 SCF=0.8 20.0
requirement
150.0 104.274 7.3 3.5 3.2
Table 2 Conversion of Financial Costs into Social Costs (Rs. in million)

Item Financial Basis of Tradeable value T L R
cost conversion ab initio
Indigeneous raw material 85 SCF=0.8 68
and stores
Labour 7 SCF=0.5 3.5
Salaries 5 SCF=0.8 4.0
Repairs and maintenance 1.2 SCF=1/1.5 0.8
Water, fuel, etc 6 T=0.5, L=0.25 3 1.5 1.5
R=0.25
Electricity (Rate portion) 5 T=0.71, L=0.13 3.55 0.65 0.8
R=0.16
Other overheads 10 SCF=1/1.5 6.667
119.2 82.967 6.55 2.15 2.3
As per table 1, the social cost of initial outlay is worked out as follows :
Rs. in million
Tradeable value ab initio 104.274
Social cost of the tradeable component 4.867
(7.3 / 1.5)
Social cost of labour component 1.75
(3.5 x 0.5)
Social cost of residual component 1.60
(3.2 x 0.5)
Total 112.491
As per Table 2, the annual social cost of operation is worked out as follows :
Tradeable value ab initio 82.967

Social cost of the tradeable component 4.367
( 6.55 x 1/1.5 )
Social cost of labor component 1.075
(2.15 x 0.5)
Social cost of residual component 1.150
(2.3 x 0.5)
Total 89.559
The annual CIF value of the output is Rs.110 million. Hence the annual social
net benefit will be : 110 – 89.559 = Rs.20.441 million
Working capital recovery will be Rs.20 million at the end of the 20th year.
Putting the above figures together the social flows associated with the project
would be as follows :
Year / ’s Social flow (Rs. in million)

0 -112.491
1-19 20.441

Project Evaluation and Feasibility Analysis

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Project Evaluation and Feasibility Analysis

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Problems’ Solutions Project Evaluation

Chapter 4 MARKET AND DEMAND ANALYSIS

1. We have to estimate the parameters a and b in the linear relationship

∑TY–nTY 421,600 – 14 x 7.5 x 3,464

Where Ft + 1 = forecast for year ) α = smoothing parameter

1 2,000 2100.0 -100 F2 = 2100 + 0.3 (-100) = 2070

3. According to the moving average method

Given n = 3, the forecasts for the period 4 to 14 are given below:

Period t Data (St) Forecast Forecast for t + 1

P1 , Q1 = Price per unit and quantity demanded in the base year

1. Projected Cash Flow Statement (Rs. in million)

Opening cash balance 1.00

Projected Balance Sheet (Rs. in million)

2. Projected Income Statement for the 1st Operating Year

Projected Balance Sheet

ii. Depreciation Schedule:

iii. Interest Schedule:

r = 8% FV5 = 1000 x FVIF (8%, 5 years)

r = 10% FV5 = 1000 x FVIF (10%, 5 years)

r = 12% FV5 = 1000 x FVIF (12%, 5 years)

r = 15% FV5 = 1000 x FVIF (15%, 5 years)

2. Rs.160,000 / Rs. 5,000 = 32 = 25

According to the Rule of 72 at 12 percent interest rate doubling takes place

So Rs.5000 will grow to Rs.160,000 in approximately 5 x 6 years = 30 years

According to the Rule of 69, the doubling period is:

0.35 + 69 / Interest rate

Equating this to 4 and solving for interest rate, we get

Interest rate = 18.9%.

Hence the savings will cumulate to:

2000 x FVIFA (10%, 15 years) + 1000 x FVIFA (10%, 10 years)

5. Let A be the annual savings.

A x FVIFA (12%, 10 years) = 1,000,000

So A = 1,000,000 / 17.549 = Rs.56,983.

6. 1,000 x FVIFA (r, 6 years) = 10,000

FVIFA (r, 6 years) = 10,000 / 1000 = 10

From the tables we find that

FVIFA (20%, 6 years) = 9.930

Using linear interpolation in the interval, we get:

20% + (10.000 – 9.930)

7. 1,000 x FVIF (r, 10 years) = 5,000

From the tables we find that

Using linear interpolation in the interval, we get:

r = 12% PV = 10,000 x PVIF (r = 12%, 8 years)

r = 15% PV = 10,000 x PVIF (r = 15%, 8 years)

2,000 x PVIFA (10%, 5years)

10,000 x PVIFA (15%, 15 years)

The alternative is to receive a lump-sum of Rs.50,000.

11. The amount that can be withdrawn annually is:

12. The present value of the income stream is:

1,000 x PVIF (12%, 1 year) + 2,500 x PVIF (12%, 2 years)

= 1,000 x 0.893 + 2,500 x 0.797 + 5,000 x 4.968 x 0.797 = Rs.22,683.

13. The present value of the income stream is:

2,000 x PVIFA (10%, 5 years) + 3000/0.10 x PVIF (10%, 5 years)

15. Rs.20,000 =- Rs.4,000 x PVIFA (r, 10 years)

From the tables we find that:

PVIFA (15%, 10 years) = 5.019

Using linear interpolation we get:

16. PV (Stream A) = Rs.100 x PVIF (12%, 1 year) + Rs.200 x

= Rs.100 x 0.893 + Rs.200 x 0.797 + Rs.300 x 0.712

17. FV5 = Rs.10,000 [1 + (0.16 / 4)]5x4

18. FV5 = Rs.5,000 [1+( 0.12/4)] 5x4

Stated rate (%) 12 24 24

= 12.6 = 26.2 = 26.8