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= 254
227.5
a = Y bT
= 3,464 254 (7.5)
= 1,559
T2
1
4
9
16
25
36
49
64
81
100
121
144
169
196
T 2 = 1,015
2,000
2,200
2,100
2,300
2,500
3,200
3,600
4,000
3,900
4,000
4,200
4,300
4,900
2100.0
2070
2109.0
2111.7
2168.19
2267.7
2547.4
2863.2
3204.24
3413
3589.1
3772.4
3930.7
-100
130
-9
188.3
331.81
932.3
1052.6
1136.8
695.76
587.0
610.9
527.6
969.3
Period
t
Data (St)
1
2
3
4
5
6
7
8
9
10
11
12
13
14
2,000
2,200
2,100
2,300
2,500
3,200
3,600
4,000
3,900
4,000
4,200
4,300
4,900
5,300
Forecast
(Ft)
2100
2200
2300
2667
3100
3600
3833
3967
4033
4167
4467
Forecast for t + 1
Ft + 1 = (St+ S t 1 + S t 2)/ 3
4.
Q1 = 60
Q2 = 70
I1 = 1000
I2 = 1200
Q1 Q2
Income Elasticity of Demand E1 =
I2 - I1
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
E1 =
1000 + 1200
x
1200 1000
22000
E1 =
= 0.846
26000
70 + 60
I1 + I2
x
Q2 Q1
5.
P1 = Rs.40
P2 = Rs.50
Q1 = 1,00,000
Q2 = 95,000
Q2 Q1
P1 + P2
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
Price Elasticity of Demand = Ep =
95000 - 100000
Ep =
40 + 50
x
50 - 40
- 45
Ep =
= - 0.0231
1950
95000 + 100000
Chapter 6
FINANCIAL ESTIMATES AND PROJECTIONS
1.
Projected Cash Flow Statement
Sources of Funds
Profit before interest and tax
Depreciation provision for the year
Secured term loan
Total (A)
Disposition of Funds
Capital expenditure
(Rs. in million)
4.5
1.5
1.0
7.0
1.50
0.35
0.50
1.20
Total (B)
Opening cash balance
Net surplus (deficit) (A B)
Closing cash balance
1.80
1.00
6.35
1.00
0.65
1.65
2.
5.00
4.50
4.50
3.00
6.30
1.05
24.35
(Rs. in million)
Assets
Fixed assets
11.00
Investments
.50
Current assets
12.85
* Cash
1.65
* Receivables 4.20
* Inventories 7.00
24.35
Sales
Cost of sales
Depreciation
Interest
Write off of Preliminary expenses
Net profit
Rs.
4,500
3,000
319
1,044
15
122
1800
3000
4800
600
1800
1166
319
15
3900
3900
150
600
4650
0
150
150
2400
1044
3444
150
456
606
31/3/n+1
4500
31/3/n+2
4181
150
606
2400
150
135
4800
7322
i.
ii.
Allocation
Costs after
allocation
19
97
415
69
600
139
727
3115
519
4500
Depreciation Schedule :
Opening balance
Depreciation
Closing balance
iii.
Costs
before
allocation
120
630
2700
450
3900
Lan
d
139
139
Building
727
25
702
3115
252
2863
M.Fixed
assets
519
42
477
Total (Rs.)
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
4500
319
4181
Chapter 7
THE TIME VALUE OF MONEY
1.
2.
8%
FV5
=
=
10%
FV5
=
=
12%
FV5
=
=
15%
FV5
=
=
3.
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)
=
5.
6.
Rs.79481.
1,000,000
1,000,000
So A = 1,000,000 / 17.549 =
Rs.56,983.
10,000
10,000 / 1000 = 10
=
=
9.930
10.980
x 4% = 20.3%
(10.980 9.930)
7.
=
=
5,000
5,000 / 1000 = 5
4.411
5.234
= 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
r = 15%
9.
PV
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 lumpsum of Rs.50,000.
Obviously, Mr. Jingo will be better off with the annual pension amount of
Rs.10,000.
11.
12.
13.
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:
=
=
5.019
4.494
5.019 5.00
---------------5.019 4.494
x 3%
= 15.1%
16.
17.
FV5
=
=
=
=
18.
FV5
=
=
=
=
19.
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
=
PVIF(12%, 8 years)
21.
= Rs.40,388
2.476
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
FV10
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.
Rs.50,000
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:
=
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.
26.
of
Assuming that the monthly interest rate corresponding to an annual interest rate
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 =
P x 1.817
=
P
27.
Rs.14,998
Rs.14,998
Rs.14,998
------------ = Rs.8254
1.817
Rs.6000 / Rs.300
= 20
21.244
18.914
21.244 20.000
---------------------21.244 18,914
x 1%
= 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.
A
A
A
A
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
From the tables we find that
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
n=7+
30.
5.000 4.868
----------------5.335 4.868
x 1 = 7.3 years
= 500000 / PVIFA(14%,4)
= 500000 / 2.914
= Rs.171,585
Beginning
amount
500000
398415
282608
150588
Annual
installment
171585
171585
171585
171585
Interest
70000
55778
39565
21082
Principal
repaid
101585
115807
132020
150503
Remaining
balance
398415
282608
150588
85*
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.
= Rs.300 million x
= Rs.300 million x
1 (1 + g)n / (1 + i)n
-----------------------i-g
1 (1.06)15 / (1.16)15
0.16 0.06
Chapter 8
INVESTMENT CRITERIA
1.(a)
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
=
(b)
- 44837
- 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)
=
=
2.
Investment A
a)
b)
Payback period
NPV
=
=
5 years
40000 x PVIFA (12%,10) 200 000
c)
=
26000
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)
PVIFA (16%,10)
=
=
5.019
4.883
d)
r =
=
15 + 1 x (0.019 / 0.136)
15.14%
BCR
=
=
=
Investment B
a)
Payback period
b)
NP V =
=
c)
9 years
d)
BCR
Investment C
=
=
PVB / I
194,661 / 300,000
= 0.65
a)
c)
NPV
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
c)
d)
BCR
Investment
PVB / I
=
282,840 / 320,000
Comparative Table
A
0.88
D
a) Payback period
(in years)
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
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 cashflow 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 cashflow, we get two values for the
IRR of the cashflow stream. In such cases, the IRR rule breaks down.
5.
Define NCF as the minimum constant annual net cashflow 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.
8.
PV of benefits (PVB) =
+
+
+
+
=
Investment
=
Benefit cost ratio
=
(A)
(B)
9.
(a)
400
223
69
- 66
- 291
- 386
500
251
40
- 142
- 435
- 555
R
600
312
70
- 135
- 461
- 591
NPV profiles for Projects P and Q for selected discount rates are as follows:
Project
Discount rate (%)
0
5
10
15
20
b)
(i)
2950
1876
1075
471
11
500
208
- 28
- 222
- 382
(ii)
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)
10.
(a)
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%
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
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
PV of cash flows up to the end of year 2
PV of cash flows up to the end of year 3
PV of cash flows up to the end of year 4
=
=
=
=
12% p.a
24.97
47.75
71.26
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
PV of cash flows up to the end of year 1
PV of cash flows up to the end of year 2
(c)
=
=
=
=
Project N
Cost of capital
NPV
+ 37 x PVIF (12%,4)
Rs.21.26 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
Cost of capital
NPV
Project N
Cost of capital
NPV
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
Cost of capital =
NPV
=
Project N
Cost of capital:
NPV
=
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
12.
23.26%
1,000
10,000
2,000
8000 =
+
+
(1+r)
(1+r)2
(1+r)3
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
Year
(1+r)4
1
2
3
4
-8000
-7480
-9863.8
-1688.60
-1480
-1383.8
-1824.80
-312.39
2000
-1000
10000
2000
Unrecovered
investment balance at
the end of the year Ft-1
(1+r) + CFt
-7480
-9863.8
-1688.60
0
13.
Rs. in lakhs
Year
Investment
Depreciation
Income before
interest and tax
Interest
Income before tax
Tax
Income after tax
1
24.0
3.0
6.0
2
21.0
3.0
6.5
3
18.0
3.0
7.0
4
15.0
3.0
7.0
5
12.0
3.0
7.0
6
9.0
3.0
6.5
7
6.0
3.0
6.0
8
3.0
3.0
5.0
Sum
108
24.0
51.0
Average
13.500
3.000
6.375
2.5
3.5
3.5
2.5
4.0
1.0
3.0
2.5
4.5
2.5
2.0
2.5
4.5
2.5
2.0
2.5
4.5
2.5
2.0
2.5
4.0
2.2
1.8
2.5
3.5
1.9
1.6
2.5
2.5
1.4
1.1
20.0
31.0
14.0
17.0
2.500
3.875
1.750
2.125
2.125
=
Initial investment
B.
= 8.9%
24
2.125
=
Average investment
= 15.7%
13.5
C.
2.125 + 2.5
=
= 19.3%
Initial investment
D.
24
2.125 + 2.5
=
= 34.3%
Average investment
E.
13.5
6.375
=
Initial investment
F.
= 26.6%
24
6.375
=
Average investment
G.
= 47.2%
13.5
(24 / 2) x 8
= 17.0 / 96.0 = 17.7%
Chapter 9
PROJECT CASH FLOWS
1.
(a)
Year
(150)
(Rs. in million)
3. Revenues
250
250
250
250
250
250
250
100
100
100
100
100
100
100
5. Depreciation
37.5
6.67
7. Tax
2. Working capital
(50)
48
50
(200)
116.25 113.44 111.33 109.75 108.56 107.67
98
14.
NCF
(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.
Year
(Rs. in million)
4
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
(17+18-19+20)
(b)
(140) 10.20
NPV of the net cash flow stream @ 15% per discount rate
=
3.
(a)
Rs.1.70 million
A.
B.
3,000,000
900,000
500,000
2,600,000
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
165,000
123,750
92,813
69,609
52,207
620,000
578,750
547,813
524,609
507,207
C.
D.
Rs.
1,500,000
200,000
500,000
1,800,000
Net cash flows associated with the replacement project (in Rs)
Year
NCF
(b)
Rs.
0
(2,600,000)
620000
578750
547813
524609
5
307207
=
4.
Depreciation
charge (DC)
Tax shield
=0.4 x DC
PV of tax shield
@ 15% p.a.
25000
10000
8696
18750
7500
5671
14063
5625
3699
10547
4219
2412
7910
3164
1573
-------22051
--------
A.
B.
Rs.
400,000
90,000
310,000
Year
i. Depreciation
of old machine
18000
14400
11520
9216
7373
ii. Depreciation
of new machine
100000
75000
56250
42188
31641
82000
60600
44730
32972
24268
21210
15656
11540
8494
21210
15656
11540
8494
C.
28700
D.
Rs.
25000
10000
15000
6.
0
(310000)
1
28700
21210
15656
11540
23494
Particulars
Year
0
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
Equity funds
Revenues
Operating costs
Depreciation
Interest on working capital
advance
Interest on term loan
Profit before tax
Tax
Profit after tax
Preference dividend
Net salvage value of fixed assets
Net salvage value of current
assets
Repayment of term-loans
Redemption of preference capital
Repayment of short-term bank
borrowings
Retirement of trade creditors
Initial investment (1)
Operating cash flows (9-10+4)
Liquidation and retirement cash
flows (11+12-13-14-15-16)
Net cash flows (17+18+19)
(100)
500
320
83.33
18.00
500
320
55.56
18.00
500
320
37.04
18.00
30.00
48.67
24.335
24.335
28.50
77.94
38.97
38.97
22.50
102.46
51.23
51.23
40
40
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
Fixed assets
Working capital margin
Revenues
Operating costs
Depreciation
Interest on working capital
advance
Interest on term loan
Profit before tax
Tax @ 50%
Profit after tax
Net salvage value of fixed assets
Net recovery of working capital
margin
Initial investment (1+2)
Operating cash inflow (9+5+7
(1-T) )
Terminal cash flow (11+12)
Net cash flow (13+14+15)
16.50
120.81
60.405
60.405
40
500
320
16.46
18.00
10.50
135.04
67.52
67.52
40
500
320
10.97
18.00
4.50
146.53
73.265
73.265
200
40
100
50
(100)
(100)
107.665
107.665
94.53
54.53
88.27
48.27
85.095
45.095
83.98
43.98
84.235
90
107.665
54.53
48.27
45.095
43.98
174.235
500
320
24.69
18.00
0
(250)
(50)
1
500
320
83.33
18.00
500
320
55.56
18.00
500
320
37.04
18.00
30.00
48.67
24.335
24.335
28.50
77.94
38.97
38.97
22.50
102.46
51.23
51.23
122.665
108.78
122.665
108.78
(Rs. in million)
4
500
320
24.69
18.00
500
320
16.46
18.00
500
320
10.97
18.00
16.50
120.81
60.405
60.405
10.50
135.04
67.52
67.52
4.50
146.53
73.265
73.265
80
50
99.52
93.345
89.23
86.845
99.52
93.345
89.23
130.00
216.485
(300)
(300)
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
Total funds
Revenues
Operating costs
Depreciation
Interest on term loan
Interest on working capital
advance
Profit before tax
Tax
Profit after tax
Net salvalue of fixed assets
Net salvage value of current assets
Initial investment (1)
Operating cash inflow 9+4+6 (1-t)
+ 5(1-t)
Terminal cash flow (10+11)
Net cash flow (12+13+14)
(450)
500
320
83.33
30.00
18.00
500
320
55.56
28.50
18.00
500
320
37.04
22.50
18.00
500
320
24.69
16.50
18.00
500
320
16.46
10.50
18.00
500
320
10.97
4.50
18.00
48.67
24.34
24.34
77.94
38.97
38.97
102.46
51.23
51.23
120.81
60.41
60.41
135.04
67.52
67.52
146.53
73.265
73.265
80
200
131.67
117.78
108.52
102.35
98.23
95.485
131.67
117.78
108.52
102.35
98.23
280
375.485
(450)
(450)
Chapter 10
THE COST OF CAPITAL
1(a)
Define rD as the pre-tax cost of debt. Using the approximate yield formula, rD
can be calculated as follows:
rD
WACC
9 + (100 92)/6
-------------------0.4 x100 + 0.6x92
=
4.
5.
Define rp as the cost of preference capital. Using the approximate yield formula
rp can be calculated as follows:
rp
3.
14 + (100 108)/10
------------------------ x 100 = 12.60%
0.4 x 100 + 0.6x108
Cost of equity
=
(using SML equation)
Pre-tax cost of debt =
After-tax cost of debt =
Debt equity ratio
=
WACC
=
=
Given
0.5 x 14% x (1 0.35) + 0.5 x rE = 12%
where rE is the cost of equity capital.
Therefore rE 14.9%
Using the SML equation we get
11% + 8% x = 14.9%
where denotes the beta of Azeezs equity.
Solving this equation we get = 0.4875.
(a) The cost of debt of 12% represents the historical interest rate at the time the debt
was originally issued. But we need to calculate the marginal cost of debt (cost
of raising new debt); and for this purpose we need to calculate the yield to
maturity of the debt as on the balance sheet date. The yield to maturity will not
be equal to 12% unless the book value of debt is equal to the market value of
debt on the balance sheet date.
(b) The cost of equity has been taken as D1/P0 ( = 6/100) whereas the cost of equity
is (D1/P0) + g where g represents the expected constant growth rate in dividend
per share.
7.
The book value and market values of the different sources of finance are
provided in the following table. The book value weights and the market value
weights are provided within parenthesis in the table.
Source
Equity
Debentures first series
Debentures second series
Bank loan
Total
Book value
800 (0.54)
300 (0.20)
200 (0.13)
200 (0.13)
1500 (1.00)
(Rs. in million)
Market value
2400 (0.78)
270 (0.09)
204 (0.06)
200 (0.07)
3074 (1.00)
8.
9.
(a)
Given
rD x (1 0.3) x 4/9 + 20% x 5/9 = 15%
rD = 12.5%,where rD represents the pre-tax cost of debt.
(b)
Given
13% x (1 0.3) x 4/9 + rE x 5/9 = 15%
rE = 19.72%, where rE represents the cost of equity.
Cost of equity =
D1/P0 + g
=
3.00 / 30.00 + 0.05
=
15%
(a) The first chunk of financing will comprise of Rs.5 million of retained
earnings costing 15 percent and Rs.25 million of debt costing 14 (1-.3) = 9.8
percent.
The second chunk of financing will comprise of Rs.5 million of additional
equity costing 15 percent and Rs.2.5 million of debt costing 15 (1-.3) = 10.5
percent.
(b) The marginal cost of capital in the first chunk will be :
5/7.5 x 15% + 2.5/7.5 x 9.8% = 13.27%
Product of
(1) & (3)
4.06
0.48
4.79
1.34
1.32
11.99%
The average cost of capital using market value proportions is calculated below :
Source of capital
Component
cost
(1)
Equity capital
and retained earnings
Preference capital
Debentures
Term loans
14.5%
15.9%
9.6%
6.0%
200
7.5
40
80
327.5
11.
(a)
WACC
=
=
0.62
0.02
0.12
0.24
Average cost
capital
(b)
(c)
NPV of the proposal after taking into account the floatation costs
=
130 x PVIFA (16.37%, 8) 500 / (1 - 0.09)
=
Rs.8.51 million
Chapter 11
RISK ANALYSIS OF SINGLE INVESTMENTS
8.99
0.32
1.15
1.44
11.90%
1.
(a)
(b)
(c)
=
=
Pessimistic
(Rs. in million)
Expected
Optimistic
Investment
Sales
Variable costs
Fixed costs
Depreciation
Pretax profit
Tax @ 28.57%
Profit after tax
Net cash flow
Cost of capital
300
150
97.5
30
30
- 7.5
- 2.14
- 5.36
24.64
14%
250
200
120
20
25
35
10
25
50
13%
200
275
154
15
20
86
24.57
61.43
81.43
12%
NPV
- 171.47
21.31
260.10
Assumptions: (1)
(2)
(3)
The tax rate has been calculated from the given table i.e.
10 / 35 x 100 = 28.57%.
(4)
2.
(a)
i.
ii.
iii.
Initial investment
= 200
iv.
= 238.74 / 1.1628
(b)
= Rs.205.31 million
30000
24000
16000
3000
2000
3000
1500
1500
3500
30000
42000
28000
3000
2000
9000
4500
4500
6500
30000
54000
36000
3000
2000
13000
6500
6500
8500
-16732
- 5360
2222
Initial investment
Sale revenue
Variable costs
Fixed costs
Depreciation
Profit before tax
Tax
Pessimistic
Expected
Optimistic
30000
28000
28000
3000
2000
-5000
-2500
30000
42000
28000
3000
2000
9000
4500
30000
70000
28000
3000
2000
37000
18500
-2500
- 500
- 31895
18500
20500
47711
Initial investment
Sale revenue
Variable costs
Fixed costs
Depreciation
Profit before tax
Tax
Profit after tax
Net cash flow
NPV
(d)
4500
6500
(-) 5360
Pessimistic
Expected
Optimistic
30000
42000
56000
3000
2000
-11000
-5500
-5500
-3500
-43268
30000
42000
28000
3000
2000
9000
4500
4500
6500
- 5360
30000
42000
21000
3000
2000
16000
8000
8000
10000
7908
= Rs.5000
= 10 / 30 = 0.3333
= 5000 / 0.3333
= Rs.15000
2.
i.
ii.
iii.
iv.
Initial investment
Break-even level of sales
=
=
A2
=
=
A3
=
=
NPV
=
=
=
=
=
0.56
0.49
NPV =
+
(1.1)2
+
(1.1)4
(1.1)6
=
1.00
(NPV) = Rs.1.00 million
3.
Expected NPV
4
At
=
- 25,000
t=1 (1.08)t
=
t=1 (1.08)t
=
=
=
4.
Expected NPV
4
At
=
- 25,000
t
t=1 (1.06)
A1
=
2,000 x 0.2 + 3,000 x 0.5 + 4,000 x 0.3
=
3,100
. (1)
A2
=
=
A3
=
=
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
=
=
=
=
=
=
=
=
=
.. (2)
NPV NPV
Prob (NPV < 0) = Prob.
0 - NPV
<
NPV
NPV
0 3044
= Prob
Z<
1296
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
Pro
b
0.10
0.10
0.20
0.30
0.20
0.10
PRICE
Cumulative
Prob.
Two digit
random
numbers
0.10
0.20
0.40
0.70
0.90
1.00
00 to 09
10 to 19
20 to 39
40 to 69
70 to 89
90 to 99
Value
20
30
40
50
Pro
b
0.40
0.40
0.10
0.10
VARIABLE COST
Cumulative
Prob.
Two digit
random
numbers
0.40
0.80
0.90
1.00
00 to 39
40 to 79
80 to 89
90 to 99
Value
15
20
40
Pro
b
0.30
0.50
0.20
Cumulative
Prob.
0.30
0.80
1.00
Exhibit 2
Simulation Results
Run
QUANTITY (Q)
Rando
Corresm
ponding
PRICE (P)
Random
CorresNumber
ponding
NPV
1.8955 Q(P-V)-31,895.5
Two digit
random
numbers
00 to 29
30 to 79
80 to 99
1
2
3
4
5
6
7
8
9
Run
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
Run
37
38
39
40
41
Number
Value
03
800
32
1,200
61
1,400
48
1,400
32
1,200
31
1,200
22
1,200
46
1,400
57
1,400
QUANTITY (Q)
Rando
Corresm
ponding
Number
Value
92
1,800
25
1,200
64
1,400
14
1,000
05
800
07
800
34
1,200
79
1,600
55
1,400
57
1,400
53
1,400
36
1,200
32
1,200
49
1,400
21
1,200
08
.800
85
1,600
61
1,400
25
1,200
51
1,400
32
1,200
52
1,400
76
1,600
43
1,400
70
1,600
67
1,400
26
1,200
QUANTITY (Q)
Random
CorresNumber
ponding
Value
89
1,600
94
1,800
09
.800
44
1,400
98
1,800
value
38
20
69
30
30
20
60
30
19
20
88
40
78
30
11
20
20
20
PRICE (P)
Random
CorresNumber
ponding
value
77
30
65
30
04
20
51
30
39
20
90
50
63
30
91
50
54
30
12
20
78
30
79
30
22
20
93
50
84
40
70
30
63
30
68
30
81
40
76
30
47
30
61
30
18
20
04
20
11
20
35
20
63
30
PRICE (P)
Random
CorresNumber
ponding
value
86
40
00
20
15
20
84
40
23
20
value
17
15
24
15
03
15
83
40
11
15
30
20
41
20
52
20
15
15
VARIABLE COST (V)
Random
CorresNumber
ponding
value
38
20
36
20
83
40
72
20
81
40
40
20
67
20
99
40
64
20
19
15
22
15
96
40
75
20
88
40
35
20
27
15
69
20
16
15
39
20
38
20
46
20
58
20
41
20
49
20
59
20
26
15
22
15
VARIABLE COST (V)
Random
CorresNumber
ponding
value
59
20
25
15
29
15
21
15
79
20
-24,314
2,224
-18,627
-58,433
-20,523
13,597
-9,150
-31,896
-18,627
NPV
1.8955 Q(P-V)-31,895.5
2,224
-9,150
-84,970
-12,941
-62,224
13,597
-9,150
-1,568
-5,359
-18,627
7,910
-54,642
-31,896
-5,359
13,597
-9,150
-1,568
7,910
13,597
-5,359
-9,150
-5,359
-31,896
-31,896
-31,896
-18,627
2,224
NPV
1.8955 Q(P-V)-31,895.5
28,761
-14,836
-24,314
34,447
-31,896
42
43
44
45
46
47
48
49
50
10
38
83
54
16
20
61
82
90
1,000
1,200
1,600
1,400
1,000
1,200
1,400
1,600
1,800
Expected NPV
53
44
30
71
70
65
61
48
50
=
=
=
=
Variance of NPV
77
31
10
52
19
87
70
97
43
20
20
15
20
15
40
20
40
20
-12,941
-9,150
-16,732
-5,359
-3,463
-54,642
-5,359
-62,224
2,224
NPV
50
1/ 50 NPVi
i=1
1/50 (-7,20,961)
14,419
50
( NPVi NPV)2
i=1
1/50
30
30
20
30
30
30
30
30
30
=
=
549.481 x 106
23,441
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
I
k
F
D
T
N
S
Q
P
V
Range
Rs.30,000 Rs.30,000
10% - 10%
Rs.3,000 Rs.3,000
Rs.2,000 Rs.2,000
0.5 0.5
55
00
Can assume any one of the values 800, 1,000, 1,200, 1,400, 1,600 and 1,800
Can assume any of the values 20, 30,
40 and 50
Can assume any one of the values
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=1
(1.1)t
(1.1)5
5
=
t=1
5Q - 500
- 30,000
(1.1)t
The net present values for various values of Q are given in the following table:
Q
NPV
800
-16,732
1,000
-12,941
1,200
-9,150
1,400
-5,359
1,600
-1,568
1,800
2,224
5
=
t=1
0
+
t=1
(1.1)t
700 P 14,500
- 30,000
(1.1)t
The net present values for various values of P are given below :
P (Rs)
20
30
40
50
- 30,000
(1.1)5
NPV(Rs)
8.
-31,896
-5,359
21,179
47,716
NPV
-5
(Rs.in lakhs)
PI
0.9
10
15
20
1.00
1.10
1.20
1.30
1.40
Prob.
0.03
0.10
0.40
0.30
0.15
0.02
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)
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:
Project B:
NPV
NPV
t=1
t=1
- 10,000 = Rs.2,333
(1.12)t
11,000
- 30,000 = Rs.7,763
(1.14)t
PI
IRR
1.23
20%
1.26
24.3%
B is superior to A in terms of NPV, PI, and IRR. Hence the company must
choose B.
Chapter 12
RISK ANALYSIS OF SINGLE INVESTMENTS
1.
= wi wj ij i
2
2
2
p = w 1 1 + w 2
j
2
+ w23
+ w24
+ w25
+ 2 w1 w2 12 1 2 + 2 w1 w3 13 1 3 + 2 w1 w4 14 1 4 + 2 w1 w5
15
1 5 + 2 w2 w3 23 2 3 + 2 w2 w4 24 2 4 + 2 w2 w5 25 2 5 + 2
w3 w4
34
3 4 + 2 w3 w5 35 3 5 + 2 w4 w5 45 4
So,
(i) Since there are 3 securities, there are 3 variance terms and 3 covariance
terms. Note that if there are n securities the number of covariance terms are: 1 +
2 ++ (n + 1) = n (n 1)/2. In this problem all the variance terms are the same
( 2A) all the covariance terms are the same ( AB) and all the securities are
equally weighted ( wA = )
= [3 w2A 2A + 2 x 3 AB]
2
2
2
p = [3 w A A + 6 wA wB AB]
2
1
1
1
2
=3x
x A+ 6 x
x
x AB
3
3
3
1
2
2
=
A+
AB
3
3
(ii) Since there are 9 securities, there are 9 variance terms and 36 covariance
terms. Note that if the number of securities is n, the number of covariance
terms is n(n 1)/2.
In this case all the variance terms are the same ( 2A), all the covariance terms are
2
1
the same (
AB
So,
n(n-1)
= 9 w A
2
t 2x
2
wA wB
AB
1
= 9x
x A + 9(8) x
9
9
1
72
=
2A +
AB
9
81
x
9
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
15
16
10
-15
-5
14
10
15
12
-4
-2
12
15
12
10
9
12
9
22
13
180
RB = 180
RB = 9%
9
12
6
4
16
11
10
12
9
8
12
14
-6
2
8
7
9
10
37
10
200
RM = 200
RM = 10%
6
7
1
-24
-14
5
1
6
3
-13
-11
3
6
3
1
0
3
0
13
4
AB
Deviation
of return
on market
portfolio
from its
mean
(RM RM)
Product of
the
deviation
(RB RB)
(RM RM)
-1
2
-4
-6
6
1
0
2
-1
-2
2
4
-16
-8
-2
-3
-1
0
27
0
-6
14
-4
144
-84
5
0
12
-3
26
-22
12
-96
-24
-2
0
-3
0
351
0
(RB RB)
(RM RM)
= 320
Square of
the
deviation
of return
on market
portfolio,
from its
mean
(RM RM)2
1
4
16
36
36
1
0
4
1
4
4
16
256
64
4
9
1
0
729
0
(RB RB)2
= 1186
= 16.84
19
(RM RM)2
2
320
=
1186
=
n 1
= 62.42
19
Asset Beta
1.25
= 0.49
[1 + (2.25) x 0.7]
1.25
B
= 0.48
[1 + (2.00) x 0.7]
1.10
= 0.45
[1 + (2.1) x 0.7]
0.49 + 0.48 + 0.45
= 0.47
3
6.
[1 + D/E (1 T)]
= 1.25
D/E = 1.6
T = 0.3
1.30
=
[1 + D/E ( 1 T)]
[1 + 1.5 (1 .4)]
= 0.68
The equity beta (systematic risk) for the petrochemicals project of Growmore,
when D/E = 1.25 and T = 0.4, is
0.68 [1 + 1.25 (1 .4)] = 1.19
(b) The cost of equity for the petrochemicals project is
12% + 1.19 (18% - 12%) = 19.14%
The cost of debt is
12% (1 0.4) = 7.2%
Given, a debt equity ratio of 1.25 the required return for the petrochemicals
project is
1
1.25
19.14% x
+ 7% x
= 12.4%
2.25
2.25
Chapter 13
PV Cost
UAE =
PVIFAr,n
Cost of plastic emulsion painting
Cost of distemper painting
Discount rate
UAE of plastic emulsion painting
UAE of distemper painting
= Rs.3,00,000
Life = 7 years
= Rs. 1,80,000
Life = 3 years
= 10%
= Rs.3,00,000 / 4.868 = Rs.61,627
= Rs.1,80,000 / 2.487 = Rs.72,376
4,50,000
+
5,00,000
+
(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.
=
=
=
=
=
Rs.500,000
Rs.200,000
14%
500,000 / 3.889 = Rs.128,568
200,000 / 1.647 = Rs.121,433
Since the less costly overhaul has a lower UAE, it is the preferred alternative
4.
Gunning plow
1.
2.
3.
4.
5.
6.
7.
8.
Initial outlay
Economic life
Annual operating and maintenance costs
Present value of the stream of operating
and maintenance costs at 12% discount rate
Salvage value
Present value of salvage value
Present value of total costs (1+4-6)
UAE of 7
Rs.2,500,000
12 years
Rs.250,000
Rs.1,548,500
Counter plow
Rs.1,500,000
9 years
Rs.320,000
Rs.1,704,960
Rs.800,000
Rs.500,000
Rs.205,600
Rs.180,500
Rs.3,842,900
Rs.3,024,460
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
Current Value
Rs. in million
10
13.395
15.143
16.376
16.536
(Rupees)
Time
Operating
Post-tax
PVIF
Present Cumulative PVIFA
(t)
and
operating & (12%,t) value
present
(12%,t)
maintenance maintenance
of (3)
value
costs
costs
(1)
(2)
(3)
(4)
(5)
(6)
(7)
1
20,000
12,000
0.893
10,716
10,716
0.893
2
25,000
15,000
0.797
11,955
22,671
1.690
3
35,000
21,000
0.712
14,952
37,623
2.402
4
50,000
30,000
0.636
19,080
56,703
3.037
5
70,000
42,000
0.567
23,814
80,517
3.605
Calculation of UAE (IO) for Various Replacement Periods
UAE
(OM)
(8)
12,000
13,415
15,663
18,671
22,335
Time (t)
1
2
3
4
5
PVIFA (12%, t)
0.893
1.690
2.402
3.037
3.605
Depreciation
charge R.s.
Depreciation
tax shield
PVIF
(12%, t)
(1)
1
2
3
4
5
(2)
20,000
15,000
11,250
8,438
6,328
(3)
8,000
6,000
4,500
3,375
2,531
(4)
0.893
0.797
0.712
0.636
0.567
Time
(1)
1
2
3
4
5
PV of
depreciation
tax shield
Rs..
(5)
7,144
4,782
3,204
2,147
1,435
Cumulative
present
value Rs..
PVIFA
(12%, t)
UAE of
depreciation
tax shield Rs..
(6)
7,144
11,926
15,130
17,277
18,712
(7)
0.893
1.690
2.402
3.037
3.605
(8)
8,000
7,057
6,299
5,689
5,191
TC
Total Cost
UAE (CC) = UAE (IO) [UAE (DTS) + UAE (SV)]
UAE (TC) = UAE (OM) + UAE (CC)
7.
Time
O&M costs
Rs.
(1)
1
2
3
4
5
(2)
800,000
1,000,000
1,300,000
1,900,000
2,800,000
Time
1
2
3
4
5
Post-tax
O&M costs
Rs.
(3)
560,000
700,000
910,000
1,330,000
1,960,000
PVIF
(12%,t)
(4)
0.893
0.797
0.712
0.636
0.567
PV of posttax O&M
costs Rs.
(5)
500,080
557,900
647,920
845,880
1,111,320
Cumulative
present
value Rs.
(6)
500,080
1,057,980
1,705,9000
2,551,780
3,663,100
PVIFA
(12%, t)
(7)
0.893
1.690
2.402
3.037
3.605
UAE of
O&M
costs Rs.
(8)
560,000
626,024
710,200
840,230
1,016,117
Time
(t)
Depreciation
charge Rs.
1
2
3
4
5
1,000,000
750,000
562,500
421,875
316,406
Time
(1)
1
2
3
4
5
Depreciaton
tax shield
Rs.
300,000
225,000
168,750
126,563
94,922
PVIF
(12%, t)
0.893
0.797
0.712
0.636
0.567
PV of
depreciation
tax shield Rs.
267,940
179,325
120,150
80,494
53,821
Cumulative
present
value Rs.
267,900
447,225
567,375
647,869
701,690
PVIFA
(12%, t)
0.893
1.690
2.402
3.037
3.605
UAE of
depreciation
tax shield Rs.
300,000
264,630
236,209
213,325
194,643
Year (t)
1
2
3
4
5
6
b.
Year
1
2
3
4
5
6
Rs.750,000
750,000
600,000
450,000
300,000
150,000
Rs.300,000
300,000
240,000
180,000
120,000
60,000
Rs.260,869
226,843
157,804
102,916
59,66
25,940
843,033
2408.5
NPV
-9200
+
(1.18)2
5807.6
+
3530.8
+
(1.18)3
4633.6
+
(1.18)5
4753.8
+
(1.18)6
= Rs.3406.2 million
The dollar NPV is :
3406.2 / 46 = 74.05 million dollars
(1.18)4
Chapter 14
SOCIAL COST BENEFIT ANALYSIS
1.
Costs
1. Construction cost
2. Maintenance cost
Benefits
3. Savings in the operation
cost of existing ships
4. Increase in consumer
satisfaction
Nature
Economic
value (Rs
in million)
Oneshot
Annual
400
Annual
40
Explanation
Annual
3.6
The IRR of the stream of social costs and benefits is the value of r in the
equation
400
50
t=1
40 + 3.6 3.0
=
(1+r)t
50
t=1
40.6
(1+r)t
Rs.266,667
Rs.240,000
Rs.400,000
3.
Rs. in
million
Costs & Benefits
Time
1.
2.
3.
4.
Construction cost
Land development cost
Maintenance cost
Labour cost
0
0
1-40
0
Economic
value
24
150
1
40
5.
Labour cost
1-40
12
2-40
1-40
0.5
1-5
6-40
1
10
50
20
6.
Decrease in the value of the
timber output
Explanation
Benefits
7.
Savings in the cost of shipping the
agriculture produce
8.
Income from cash crops
9.
Income from the main crop
10.
Increase in the value of timber
output
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:
NPV
=
40
+
t=1
40
- 24 - 150 - 40 -
t=1
0.5
(1.1)t
= - Rs.9.93 million
1 + 12
(1.1)t
5
+
t=1
40
10
(1.1)t
40
+
t=6
t=2 (1.1)t
50
(1.1)t
20
+
(1.1)1
4.
Table 1
Social Costs Associated with the Initial Outlay
Rs.
in
million
Item
Financia
l cost
0.30
12.0
Imported equipment
Indigeneous equipment
Transport
15.0
80.0
2.0
6.0
Basis of
conversion
SCF = 1/1.5
T=0.50, L=0.25
R=0.25
CIF value
CIF value
T=0.65, L=0.25
R=0.10
SCF=1.5
6.0
3.7
25.0
SCF=1.0
SCF=0.02
SCF=0.8
Land
Buildings
150.0
Tradeable value
ab initio
0.20
6.0
0.074
20.0
6.0
3.0
3.0
1.3
0.5
0.2
7.3
3.5
3.2
9.0
60.0
9.0
104.274
Table 2
Conversion of Financial Costs into Social Costs
Rs.
in
million
Item
Indigeneous raw material
and stores
Labour
Salaries
Repairs and maintenance
Water, fuel, etc
Electricity (Rate portion)
Other overheads
Financia
l cost
85
Basis of
conversion
SCF=0.8
Tradeable value
ab initio
68
7
5
1.2
6
SCF=0.5
SCF=0.8
SCF=1/1.5
T=0.5, L=0.25
R=0.25
T=0.71, L=0.13
R=0.16
SCF=1/1.5
3.5
4.0
0.8
5
10
119.2
6.667
82.967
1.5
1.5
3.55
0.65
0.8
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
Social cost of the tradeable component
( 6.55 x 1/1.5 )
Social cost of labour component
(2.15 x 0.5)
Social cost of residual component
(2.3 x 0.5)
Total
82.967
4.367
1.075
1.150
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
0
1-19
Chapter 15
MULTIPLE PROJECTS AND CONSTRAINTS
1. The ranking of the projects on the dimensions of NPV, IRR, and BCR is given below
Project
NPV (Rs.)
Rank
IRR (%)
Rank
BCR
Rank
M
60,610
3
34.1
2
2.21
1
N
58,500
4
34.9
1
1.59
3
O
40,050
5
18.6
4
1.33
5
P
162,960
1
26.2
3
2.09
2
Q
72,310
2
14.5
5
1.36
4
2. The ranking of the projects on the dimensions of NPV and BCR is given below
Project
NPV (Rs.)
Rank
BCR
Rank
A
61,780
5
1.83
2
B
208,480
2
1.52
3
C
315,075
1
2.05
1
D
411,90
6
1.14
6
E
95,540
4
1.38
4
F
114,500
3
1.23
5
3. The two hypothetical projects are:
Initial outlay
Cash inflows
Year 1
Year 2
Year 3
A
B
A
10000
B
1000
5000
5000
5000
600
600
600
NPV @ 10%
2435
492
Rank
1
2
IRR
about 23%
above 35%
Rank
2
1
4. The two hypothetical 4-year projects for which BCR and IRR criteria give different
rankings are given below
Project
A
B
Investment outlay
20000
20000
Cash inflow
Year 1
2000
Year 2
2000
Year 3
2000
Year 4
31500
Project
NPV
A
4822
B
4296
8000
8000
8000
8000
Rank
1
2
IRR
19%
about 22%
Rank
2
1
Outlay
(Rs.)
20,000
75,000
100,000
95,000
120,000
NPV
(Rs.)
5,851
5,025
6,995
10,876
12,846
5 X1 + 6 X2 + 5 X3 + 10 X4 + 12 X5
+ 40 X6 60
Power constraint
15 X1 + 20 X2 + 30 X3 + 35 X4 + 40 X5
+ 60 X6 120
Managerial constraint
55 X1 + 75 X2 + 50 X3 + 60 X4 + 105 X5 + 12 X6 + 60 X7 + 120 X8
+ 50 X9 + 40 X10 + 100 X11+ 178.2 X12
Subject to
75 X1 + 80 X2 + 75 X3 + 35 X4 + 80 X5 + 20 X6 + 70 X7 + 155 X8 +
55 X9 + 10 X10 + 109.3 X12 + SF1 = 400
40 X1 + 85 X2 + 8 X3 + 100 X4 + 160 X5 + 9 X6 + 5 X7 + 100 X8 + 20
X9 + 90 X10 + 155 X11+ 247 X12 + SF2 = 350 + SF1 (1 + r)
X3 + X7
X5 + X8 + X9 + X10
X2
X8
X4 + X5 + X12
X8 + X11
Xj = {0,1}
SFi 0
1
2
X6
X9
1
1
j = 1, 2.12
i = 1, 2
It has been assumed that surplus funds can be shifted from one period to the next
and they will earn a post-tax return of r percent.
8. Minimise [P1(3d1+ 2 d 2 + d 3) + P 2 (4 d 4 + 2 d 5 + d 6) + P 3 (d 7 d 7 )]
Subject to:
Economic Constraints
12 X1 + 14 X2 + 15 X3 + 16 X4 + 11 X5 + 23 X6 + 20 X7 65
Goal Constraints
+ 0.9 X6 + 1.8 X7 + d 1 d 1 = 6
+ 2.5 X6 + 2.0 X7 + d 2 d 2 = 8
+ 4.0 X6 + 2.2 X7 + d 3 d 3 = 10
+ 1.0 X6 + 2.0 X7 + d 4 d 4 = 6
+ 3.0 X6 + 3.0 X7 + d 5 d 5 = 8
+ 3.5 X6 + 3.5 X7 + d 6 d 6 = 10
4 X1 + 5 X2 + 6 X3 + 8 X4 + 4 X5
+ 9 X6 + 7 X7 + d 7 d 7 = 50
Xj 0
NPV
d i, d i 0
9. The BCRs of the projects are converted into NPVs as of now as follows
Project
1
2
3
4
5
6
7
8
9
Outlay (Rs.)
800,000
200,000
400,000
300,000
200,000
500,000
400,000
600,000
300,000
BCR
1.08
1.35
1.20
1.03
0.98
1.03
1.21
1.17
1.01
NPV (Rs.)
64,000
70,000
80,000
9,000
- 4,000
15,000/1.10 = 13,636
84,000/1.10 = 76,364
102,000/1.10 = 92,727
3,000/1.10 = 2,727
Maximise
Subject to
800,000 X1 + 200,000 X2 + 400,000 X3 + 300,000 X4 + SF1 = 20,00,000
500,000 X6 + 400,000 X7 + 600,000 X8 + 300,000 X9 500,000 + SF1 (1.032)
Xj = {0,1}
j = 1, 2, 3, 4, 6, 7, 8, 9
Chapter 16
VALUATION OF REAL OPTIONS
1.
S = 100 , uS = 150, dS = 90
u = 1.5 , d = 0.9, r = 1.15 R = 1.15
E = 100
Cu = Max (uS E, 0) = Max (150 100,0) = 50
Cd = Max (dS E, 0) = Max (90 100,0) = 0
Cu Cd
50
=
= 0.833
(u-d)S
0.6 x 100
u Cd d Cu
0 0.9 x 50
B =
=
(u-d)R
0.6 x 1.15
C =
2.
= - 65.22
S = 60 , dS = 45, d = 0.75, C = 5
r = 0.16, R = 1.16, E = 60
Cu = Max (uS E, 0) = Max (60u E, 0)
Cd = Max (dS E, 0) = Max (45 60, 0) = 0
Cu Cd
60u 60
=
(u-d)S
(u 0.75)60
u Cd d Cu
=
(u-d)R
45 (1 u)
=
(u 0.75) 1.16
1.16 (u 0.75)
S+B
(u 1) 60
5 =
u 0.75
B =
C =
u1
45 (1 u)
+
u 0.75
1.16 (u 0.75)
Multiplying both the sides by u 0.75 we get
45
5(u 0.75) = (u 1) 60 +
(1 u)
1.16
Solving this equation for u we get
u = 1.077
So Betas equity can rise to
60 x 1.077 = Rs.64.62
3.
E
C0 = S0 N(d1) -
N (d2)
rt
e
S0 = 70, E = 72, r = 0.12, =
0.3, t = 0.50
S0
ln
1
+
r+
d1 =
70
ln
=
0.30 0.50
- 0.0282 + 0.0825
=
= 0.2560
0.2121
d2 = d1 -
t = 0.2560 0.30
N (d1) = 0.6010
N (d2) = 0.5175
E
=
ert
0.50 = 0.0439
72
= 67.81
e0.12x 0.50
E
C0 = S0 N(d1) -
N (d2)
ert
E = 50, t = 0.25, S = 40, =
0.40, r = 0.14
S0
ln
1
+
r+
d1 =
40
ln
d1 =
0.40 0.25
- 0.2231 + 0.055
=
= - 0.8405
0.20
d2 = d1 -
t = - 0.8405 0.40
N (d1) = 0.2003
N (d2) = 0.1491
E
=
rt
e
0.25 = -1.0405
50
= 48.28
e
0.14 x 0.25
ln
+ r+
E1
2
d1 =
t
d2 =
d1 -
t
-0.854 + (0.12 + (.09/2)) 4
=
-0.194
=
0.3 4
= -0.323
0.6
Given a risk free rate of 10 percent, the risk-neutral probabilities must satisfy the
following conditions:
p x 1.6 + (1 p) x 120
1.2 million =
1.10
Solving this we get p = 0.3
Step 2: Calculate the expected cash flow next year
The expected cash flow next year is:
0.3 x 5.5 + 0.7 x 0.9 = Rs.2.28 million
Step 3: Compute the current value
2.28/ 1.10 = Rs.2.07 million
Since Rs.2.07 million is greater than Rs.1.80 million, the profit from
constructing a 9 unit building now, it is advisable to keep the vacant land. The value of
the vacant land is Rs.2.07 million.
7.
S0 = current value of the asset = value of the developed reserve discounted for
3 years (the development lag) at the dividend yield of 5% = $20 x 100/
(1.05)3 = $1727.6 million.
E = exercise price = development cost = $600 million
= standard deviation of ln (oil price) = 0.25
t = life of the option = 20 years
r = risk-free rate = 8%
y = dividend yield = net production revenue/ value of reserve = 5%
Given these inputs, the call option is valued as follows:
Step 1 : Calculate d1 and d2
S
2
ln
+ ry
t
E
2
d1 =
d1 -
20
Chapter 21
PROJECT MANAGEMENT
1.
a. Cost variance: BCWP ACWP = 5,500,000 5,800,000
= Rs.300,000
b. Schedule variance in cost terms: BCWP BCWS = 5,500,000
6,00,000 = Rs.500,000
5,500,000
c. Cost performance index: BCWP/ ACWP =
= 0.948
5,800,000
5,500,000
= 0.916
6,000,000
BCTW
e. Estimated cost performance index:
10,000,000
=
(ACWP + ACC)
5,800,000 + 5,000,000
= 0.926
Chapter 22
NETWORK TECHNIQUES FOR PROJECT MANAGEMENT
2. The net work diagram with the earliest and latest occurrence times for each event is
shown in Exhibit 1.
Exhibit 1
Network for the Project
2
5
11 11
4 4
4
1
0 0
4
9 9
7
14 14
3
2 3
There are two critical paths: 1-2-4-5-7 and 1-2-4-7. The minimum time required
for completing the project is 14 weeks.
Optimistic to
Most likely tm
Pessimistic tp
Average
to + 4 tm + tp
te =
1-2
1-3
1-4
1-7
2-4
2-6
2-7
3-4
4-5
5-6
3-7
6-7
4
3
5
2
6
3
5
3
2
1
2
1
6
7
6
4
10
4
9
7
4
3
5
2
10
12
9
6
20
7
15
12
5
6
8
6
(a) The network diagram with average time estimates is shown in Exhibit 3.
4
6 1/3
7 1/6
6 1/3
4
11
4 1/3
9 1/3
7 1/6
3 5/6
3 1/6
5
2 1/2
Exhibit 3
2
6
EOT LOT
11
6
3
4
17
5
17
21 21
6
24 24
7
6
3
7
10
5
7
1
0
4
0
7
26
26
Event
1
2
3
4
5
6
7
Exhibit 3
Event slacks
LOT
0
6 1/3
10 1/6
17 1/3
21 1/6
24 1/3
26 5/6
EOT
0
6 1/3
7 1/6
17 1/3
21 1/6
24 1/3
26 5/6
Free Float
EOT(j) EOT(i) dij
0
0
11
22 5/6
0
13 2/3
11 1/6
3
14 2/3
0
0
0
Independent Float
EOT(j) LOT (i) dij
0
0
11
22 5/6
0
13 2/3
11 1/6
0
11 2/3
0
0
0
Duration
dij
6 1/3
7 1/6
6 1/3
4
11
4 1/3
9 1/3
7 1/6
5
3 5/6
3 1/6
2 1/2
Total Float
LOT(j) EOT(i) dij
0
3
11
22 5/6
0
13 2/3
11 1/6
3
14 2/3
0
0
0
(d) Standard deviation of the critical path duration = [Sum of the variances of activity
durations on the critical path]1/2
The variances of the activity durations on the critical path are shown in Exhibit 5.
Exhibit 5
Variances of Activity Durations on critical path
Activity
tp
to
tp to
=
6
1-2
10
4
1.00
2-4
12
6
1.00
4-5
5
2
0.50
5-6
6
1
0.83
6-7
6
1
0.83
The standard deviation of the duration of critical path is:
1.00
1.00
0.25
0.69
0.69
30 25.5
<
= 0.87
4.
7
9
12
12
(b) The all-normal critical paths are 1-2-4-6-7-9 and 1-3-4-6-7-9. For all-normal
network, the project duration is 34 weeks and the total direct cost is
Rs.66,000.
(c) The time-cost slope of the activities constituting the project is given in
Exhibit 7.
(1)
Activity
(1-2)
(2-4)
(1-3)
(3-4)
(4-7)
(3-5)
(4-6)
(6-7)
(7-9)
(5-9)
Time
in weeks
(2)
Normal
5
6
4
7
9
12
10
7
6
12
Exhibit 7
Time-Cost Slope of Activities
Cost (Rs.)
(3)
Crash
2
3
2
4
5
3
6
4
4
7
(4)
Normal
6,000
7,000
1,000
4,000
6,000
16,000
15,000
4,000
3,000
4,000
(5)
Crash
9,000
10,000
2,000
8,000
9,200
19,600
18,000
4,900
4,200
8,500
Examining the time-cost slope of activities on the critical path, we find that
activity (6-7) has the lowest slope on both the critical paths. The project network after
crashing this activity is shown below in Exhibit 8.
Exhibit 8
6
10
2
4
9
12
12
As per Exhibit 8, the critical paths are (1-3-4-6-7-9) and (1-2-4-6-7-9) with a
length of 31 weeks and the total cost is Rs.66,900.
Looking at the time-cost slope of the activities on the critical paths (1-3-4-6-7-9)
and (1-2-4-6-7-9), we find that activities (1-3) and (7-9) have the least time-cost slopes
on the two critical paths respectively. The project net work after crashing these
activities is shown in Exhibit 9.
Exhibit 9
6
10
2
4
9
12
12
As per Exhibit 9, the critical path is (1-2-4-6-7-9) with a length of 29 weeks and
the total direct cost is Rs.(66,900 + 2,200) = Rs.69,100. Activity (4-6) has the least
time-cost slope on the critical path. Hence this is crashed the net work after crashing
(4-6) is shown in Exhibit 10.
Exhibit 10
6
6
2
4
9
12
12
As per Exhibit 10, the critical path is (1-3-5-9), with a length of 26 weeks, and
total direct costs of Rs.72,100. Looking at the time-cost slope of the non-crashed
activities on this path we find that activity (3-5) has the lowest slope. Hence it is
crashed. The project net work after such crashing is shown in Exhibit 11.
Exhibit 11
6
6
2
12
As per Exhibit 11, the critical path is (1-2-4-6-7-9), with a length of 25 weeks
and a total direct cost of Rs.75,700.
Looking at the time cost slope of the activities on this critical path, we find both
activities (1-2) and (2-4) have the same slope. We crash activity (2-4). The resulting
project network net work is given in Exhibit 12.
Exhibit 12
6
6
2
12
As per Exhibit 12, the critical path is (1-3-4-6-7-9), with a length of 23 weeks
and a total direct cost of Rs.78,700. Crashing activity (3-4), the only uncrashed activity
on this critical path, we get the net work shown in Exhibit 13.
Exhibit 13
6
6
2
4
9
12
As per Exhibit 13, the critical path is (1-2-4-6-7-9), with a length of 22 weeks
and a total direct cost of Rs.82,700. The only uncrashed activity on this critical path is
(1-2). Crashing this we get Exhibit 14.
Exhibit 14
6
6
2
4
9
12
As per Exhibit 14, the critical path is (1-3-4-6-7-9) with a duration of 20 weeks,
and a total direct cost of Rs.85,700. Since all activities on this path are crashed, there is
no possibility of further time reduction.
Exhibit 15 shows the time-cost relationship.
Exhibit 15
Project Duration and Total Cost
Exhibit
Activities Crashed
Project
duration
(in weeks)
6
8
9
10
11
12
13
14
none
(6-7)
(6-7), (1-3) and (7-9)
(6-7), (1-3), (7-9) and (4-6)
(6-7), (1-3), (7-9), (4-6) and (3-5)
(6-7), (1-3), (7-9), (4-6), (3-5) and (2-4)
(6-7), (1-3), (7-9), (4-6), (3-5), (2-4) and (3-4)
(6-7), (1-3), (7-9), (4-6), (3-5), (2-4), (3-4) and
(1-2)
34
31
29
26
25
23
22
20
Total
direct
cost
(Rs.)
66,000
66,900
69,100
72,100
75,700
78,900
80,500
83,500
Total
indirect
cost
(Rs.)
34,000
31,000
29,000
26,000
25,000
23,000
22,000
20,000
Total
cost (Rs.)
1,00,000
97,900
98,100
98,100
1,00,700
1,01,700
1,02,500
1,03,500
If the objective is to minimise the total cost of the project, the pattern to crashing
suggested by Exhibit 10 may appear as the best. However, it is possible to reduce the
cost further without increasing the project duration beyond 26 weeks by decrashing
some activities on the non-critical paths. To do so, begin with the activity which has the
highest time-cost slope and proceed in the order of decreasing time-cost slope.
Chapter 23
PROJECT REVIEW AND ADMINISTRATIVE PROJECTS
1.
1.
2.
3.
4.
5.
6.
7.
2
30
139.518
3
40
126.268
4
45
101.408
5
50
68.543
6
30
26.786
126.268
101.408
68.543
26.786
-13.250
-24.860
-32.865
-41.757
-26.786
16.750
15.140
12.135
8.243
3.214
0.12
0.12
0.12
0.12
0.12
13.250
24.860
32.865
41.757
26.786
2
30
122.412
3
40
97.929
4
45
73.446
5
50
48.963
6
30
24.480
97.929
73.446
48.963
24.480
-24.483
-24.483
-24.483
-24.483
-24.483
5.517
0.045
15.517
0.158
20.517
0.274
25.517
0.521
5.52
0.225
24.483
24.483
24.483
24.483
24.483
Year
1
Cash flow
25
Book value at the 146.895
beginning of the year,
straight line depreciation
Book value at the end of 122.412
the year, straight line
depreciation
Change in book value -24.483
during the year (3 2
Book income (1 + 4)
0.517
Book
return
on
.004
investment (5/2)
Book depreciation
24.483
2.
SV = Rs.120 million
DV = Rs.175 million
30
PVCF
35
+
45
+
(1.12)
(1.12)2
30
25
50
+
(1.12)3
(1.12)4
= Rs.148.21 million
(1.12)
(1.12)