REPORT ON

COMPARISON BETWEEN TWO INVESTMENTS APPRAISALS

-A CASE STUDY ON PRAN-RFL GROUP

Patuakhali Science and Technology University

Dumki, Patuakhali

1
 SUBMITTED TO

M. Zakir Hosen
Lecturer
Department of Accounting and Information System
Faculty of Business Administration and Management

SUBMITTED BY

Group: 05 (liberty)
Level: 03; Semester: 01
Faculty of Business Administration and Management

01 Md. Mofizer Rahaman Member 12 00671

02 Dipayan Chakma Member 17 00676
03 K.M. Assaduzzaman Member 06 00665
04 Tanjia Sultana Member 10 00669
05 Azmiry Khanom Member 20 00679
06 Shofiq Uddin Khan Member 23 00682

Financial Management-II
Course code: FBK-313

Date of Submission: 26 April, 2008

Patuakhali Science and Technology University

Dumki, Patuakhali

2
COMPARISON BETWEEN TWO INVESTMENTS APPRAISALS-
A CASE STUDY ON PRAN-RFL GROUP

LETTER OF TRANSMITTAL

3
Date: 26 April, 2008

M.ZAKIR HOSEN
Lecturer
Department of Accounting and Information System
Patuakhali Science and Technology University

Subject: Submission Term Paper on “Comparison between two investments

appraisals.”
Dear Sir,

Here we are submitting our term paper on “Comparison between two investments
appraisals” prescribed by you on your course Financial Management-II. For this
purpose, we have gone through internet, different books, articles, journals,
interview of authorities and employees of the respective organization’s for the
relevant information of the assigned topic.

Please call us for any further information at your convenient time and place.

Yours truly,

Group 05 (Liberty)
BBA
Level- III Semester- I
Session: 2004-2005
Patuakhali Science and Technology University

LETTER OF AUTHORIZATION

4
Date: 26 April, 2008

M.ZAKIR HOSEN
Lecturer
Department of Accounting and Information System
Patuakhali Science and Technology University

Subject: Declaration regarding the validity of the report.

Dear Sir,

This is our truthful declaration that the “Comparison between two investments
appraisals” we have prepared is not a copy of any report previously made by any
group.

We also express our honest confirmation in support of the fact that the said
“Report” has neither been used before to fulfill any other course related purpose
nor it will be submitted to any other person or authority in future.

Yours truly,

Group 05 (liberty)
BBA
Level-III Semester-I
Session: 2004-2005
Patuakhali Science and Technology University

5
ACKNOWLEDGEMENT

During the period of surveying PRAN-RFL group and preparing the report, we had
gained altruistic assistance from a number of persons including our honorable and
respectable course teacher M. ZAKIR HOSEN, Lecturer, Department of Accounting
and Information System, Faculty of Business Administration and Management.

We are thankful to the respective personnel specially M. Rafiq Uddin Khan of this
organization because they showed their highest degree f temperament in answering
our relentless questions. Such if their friendly cooperation and kindness did not
even allow us to strive for a single moment for.

Last of all, thanks to every members of this group. They put their spontaneous
endeavors and best effort to complete the report successfully.

6
TABLE OF CONTENTS

7
[

[
Contents Page no.
Letter of transmittal iii
Letter of authorization iv
Acknowledgement v
Executive summary viii
[

CHAPTER: 1
[[[

1.1 INTRODUCTION
02
1.2 JUSTIFICATION OF THE TERM PAPER 03
1.3 OBJECTIVES OF THE TERM PAPER
[
03

CHAPTER: 2 OVERVIEW OF THE PROJECT 1 AND PROJECT 2

2.1 INTRODUCTIONS
05
2.1.1 Overview of PRAN-RFL group 05-06
2.1.2 Overview of Project 1 (G) 06
2.1.3 Overview of Project 2 (S) 06
CHAPTER: 3 Profitability measure of the two projects
[

3.1 INTRODUCTION
08
1. Pay back period 08-09
2. Net present value (NPV) 09-10
3. Internal rate of return (IRR) 10-11

3.2 CALCULATION FOR THE CASH IN FLOWS OF THE TWO PROJECTS 12

3.2. a Cash inflows for Grinding machine
12-14
3.2. b Cash inflows for Stone Crusher machine 15-17
3.3 CALCULATION OF PAYBACK PERIOD OF TWO PROJECTS 15
3.3.a Calculation of Pay back period of grinding machine 18-19
3.3. b Pay back period of stone crushing machine 19-20
3.4. CALCULATION OF NET PRESENT VALUE OF TWO MACHINES
3.4. a Calculation OF NET present value (NPV)
of grinding machine
21
3.4.b Calculation of Net present value (NPV) of Stone Crusher 22
3.5 CALCULATION OF INTERNAL RATE OF RETURN OF TWO PROJECTS
3.5. a Calculation of Internal rate of return
(IRR) of Grinding machine 23
TABLE OF CONTENTS ( CONTINUE)-

8
3.5. b Calculation of Internal rate of return
(IRR) of Stone Crusher Machine
23
3.6 NPV PROFILE OF GRINDING MACHINE AND
STONE CRUSHER MACHINE
24-25
3.7 PROFITABILITY INDEX (PI) OR BENEFIT-COST RATIO
(B/C RATIO) OF THE TWO PROJECTS
3.7 a Calculation for profitability Index of Grinding Machine 26
3.7. b Calculation of profitability index
for Stone Crusher Machine 26
3.8 COMMENTS ON THE OVERALL CALCULATION
3.8.1 Comments in respect of NPV 27
3.8.2 Comments in respect of IRR 27
3.8.3 Comments in respect of profitability index 27-28
CHAPTER: 4 Summary, Conclusion & Recommendation
4.1 SUMMARY
30
4.2 CONCLUSION
31
4.3 RECOMMENDATION
32
4.4 Bibliography 33

9
EXECUTIVE SUMMERY
This report is an assigned job as partial fulfillment of course requirement by
honorable course teacher M. ZAKIR HOSEN, Lecturer, Department of Accounting and
Information System, faculty of Business Administration and Management,
Patuakhali Science and Technology University, Dumki, Patuakhali. The view of
this report is to find out the comparison between two investments proposals ( of
PRAN-RFL group).

PRAN-RFL group is now in a great position in the business sector not only in
Bangladesh but also in the world. For this reason to earn adequate profit and
compete extremely well with the other business organization PRAN-RFL group
need to calculate their investment appraisals. According to our survey, we found
that PRAN-RFL group tries to calculate the profitability measures to accept or
reject any project.

10
CHAPTER: 1

11
 1.1 INTRODUCTION

Investment is very much important for business. It is absurd to earn profit

with out investment. But there is an important thing in investment is
investment decision. The investment decision must be taken in that way that
the firm can earn the maximum profit. Any default in making investment
decision can make a serious damage for any firm. For this reason, they have
to follow a structured process. In the language of finance, it is called Capital
Budgeting. Capital Budgeting is employed to evaluate expenditure decisions
which involve current outlays but are likely to produce benefits over a period
of time longer than one year. This benefit may be either in the form of
increase revenues and or reduced costs.

Capital expenditure management therefore, include addition, disposition,

modification and replacement of fixed assets. The term Capital Budgeting is
used interchangeably with—

• Capital expenditure decision,

• Capital expenditure management,
• Long-term investment decision,
• Management of fixed assets and so on.

12
 1.2 JUSTIFICATION OF THE TERM PAPER

This term paper is about the comparison between two investments appraisal.
Which is very much related with the capital budgeting techniques. So the
techniques or procedure of justify capital budgeting are also the elements of
justify this term paper. That is why, to justify this term paper we can use
some capital budgeting evaluation techniques. They are—

1. Pay back period (PB)

2. Net present value (NPV)
3. Internal rate of return (IRR)
4. Profitability index (PI) or benefit -cost ratio (BC).

1.3 OBJECTIVES OF THE TERM PAPER

As a business expectative of future, we should have to gather experience beside

our institutional education. We should not concern our lesson only in classroom
but to implement it in practical life that will help us in our future life.

So, identify objectives is very much important. Our purpose of preparing the repot
is:

• To identify and know the techniques of investment decision.

• To identify how the organization make their investment decisions.

13
• To find out how effectively the Capital Budgeting technique works.

• To learn about the investment appraisal.

CHAPTER: 2
OVERVIEW OF THE PROJECT 1 AND PROJECT 2

14
 2.1 INTRODUCTIONS

2.1.1 Overview of PRAN-RFL group

“Poverty and hunger are curses”- mission of PRAN-RFL group. So their aim
is “to generate employment and earn dignity and self respect for our
competitors” through profitable enterprises.

For the achievement of this mission and aim the most recognized PRAN-
RFL group was established and started manufacturing in 1982.

PRAN means,

• P- Program for
• R- Rural
• A-Advancement
• N- Nationality

RFL means,
• R- Rangpur
• F- Foundry
• L- Limited
(It is a water pump and plastic pipe industry)
From the time being it has now 17 associated firms and they are beverage,
property, agro based, tube wells, plastic pipes, etc. these associated
industries are in—
 Natore
 Rangpur
 Ghorashal and
 Dhaka

15
It has already been obtained the ISO certificate. Their ISO mark is ISO-9001
and it was obtained after the three years of their manufacturing.
Major General (Ret) Amzad Khan Chowdhry people of Natore, was the
founder and the managing director of PRAN-RFL group. His son Mr. Ahsan
Khan Chowdhury is the deputy managing director of this group.

PRAN-RFL group is now one of the greatest and significant and most
successful company in Bangladesh. They are now challenging the other
multinational companies. They are now sending their products to abroad by
ensuring their quality. Their export products such as rice, dal, mango bar,
juice, mineral water, chatni, tea, white vinegar etc. They are a raising and
developing company in Bangladesh. They may be and ideal for infant
industries of our country.

2.1.2 Overview of Project 1 (G)

PRAN-RFL group has 17 firms. With in 17 firms spices firm is one of the
major firms in their business. It is marely a new firm. But this is a profitable
one. They earn a lot of profit from this business. Now a days, they are now
thinking of expanding it, because the demand of their product is increasing
day by day. And they are now exporting it into several foreign countries.
There is an another thing that two exists in the competitive foreign trade
market they need modern equipment, and makes some promotional activities
with the old product. To crush and dust the several spices in a proper way
they need a new crusher machine. And in the market they have opportunity
to buy two different machines. And the one of them is “Grinding machine
(G).” This machine is made in Japan and the cost of this machine is $ 29000.
This machine has 15 years of estimated life. This machine can produce raw
materials for the next department for about 10000 units (1 packet = 50 gram)
per day. It has no other installation cost and no additional modification cost.
After 15 years it can be sold by $2000.

2.1.3 Overview of Project 2 (S)

The another option is the “Stone crusher machine.” This machine is made
from Germany and the purchase price is $ 35000. This machine has also 15

16
years of estimated life. After that, it can be sold by $ 2000. It has no other
installation cost and no additional modification cost. The machine can
produce raw materials for the next department for about 12000 units (1
packet = 50 gram) per day.

So the management are in a dilution that which machine will be purchased to

earn more profit and which can increase their inflows. This dilution can be
removed through some measurement. They are the NPV calculation, IRR
calculation and profitability index calculation.

CHAPTER: 3
Profitability measure of the two
projects

17
 3.1 INTRODUCTION

Profitability measurement is an important thing to increase a firm’s

future growth. There are three popular methods in business to evaluate
capital budgeting projects. They are
1. Pay back period (PB)
2. Net present value (NPV)
3. Internal rate of return (IRR)
There is a another measurement which is profitability index (PI).

1. Pay back period

It is a non-discounting technique to evaluate the capital budgeting process.

The back period can be defined as the length of time the original cost of an
investment is recovered from the expected cash flows. To compute a
project’s pay back period, simply add up the expected cash flows for each
year until the cumulative value equals the amount that is initially invested.
The exact payback period can be found using the following formula—

Amount of investment
Number of years before unrecovred at start of the the recovery year
Payback period = full recovery of initial + Total cash flow generated during the recovery
investment
year

18
Accept-reject criterion

As a general rule, a project is considered acceptable if its payback is less

than the maximum cost recovery time established by the firm. The payback
method is simple, which explain why payback traditionally has been one of
the most popular capital budgeting techniques. But, because payback ignores
the time value of money, for this reason this method can be lead to incorrect
decisions at least if our goal is to maximize value. If a project has a payback
of three years, we know how quickly the initial investment will be covered
by the expected cash flows, but this information does not provide any
indication of whether the return on the project is sufficient to cover the cost
of the funds invested. In addition, when payback is used, the cash flow
beyond the payback period are ignored. Alternatively, the pay back can be
used as a ranking method. When mutually exclusive projects are under
consideration, they may be ranked according to the length of pay back
period. Thus the project having the shortage pay back may be assigned rank
1, followed in that order so that the project with the longest pay back would
be ranked last. Obviously, project will shorter pay back period will be
selected.

2. Net present value (NPV)

It is a discounted cash flow technique, which include the time value of
money. To find the project’s NPV, we compute the present value of all the
future cash flows that the project is expected to generate and then subtract
(add a negative cash flow) the projects initial investment (original cost). The
result is the net benefit that the firm will realize from investing in the project.
If the net benefit computed on a present value basis- that is, NPV- is
positive, then the project is considered an acceptable investment. NPV is
computed using the following equation—

Cˆ F1 Cˆ F2  Cˆ Fn 
NPV = Cˆ F  + + + .......... ... +  
(1 + k ) (1 + k )
1 2
 (1 + k )
n 

n
Cˆ Ft
= ∑(1 + k )
t =0
t

19
Here ĈFt is the expected net cash flow at Period t, and k is the rate of
return required by the firm to invest in the project. Cash out flows are treated
as negative cash flows.
An NPV of zero signifies that the project’s cash flows are sufficient to repay
the investment capital and to provide the required rate of return on that
capital.

Accept-reject criterion
If a project has a positive NPV, then it generates a return that is greater than
is needed to pay for funds provided by investors and this excess return
accrues solely to the firm’s stockholders. Therefore, if a firm takes on a
positive NPV, the position of the stockholders' position is improved because
the firm’s value is greater. In general a project is considered acceptable if
its NPV is positive, it is not acceptable if its NPV is negative. As a decision
criterion, this method can be also used to make a choice between mutually
exclusive projects. On the basis of NPV method various proposals would be
ranked of the net present values. The project with the highest NPV would be
assigned the first rank, followed by the other in the descending order.

3. Internal rate of return (IRR)

Internal rate of return is the discount rate that forces the PV of a project’s
expected cash flows to equal its initial cost. IRR also the rate of return the
firm expects to earn if the projects is purchased and held for its economic
life. As long as the project’s IRR, which is its expected return, is greater than
the rate if return required by the firm for such an investment, the project is
acceptable.

We can use the following equation to solve for a project’s IRR:

Cˆ F1 Cˆ F2 Cˆ Fn
Cˆ F + + + .......... ......... + =0
(1 + IRR ) (1 + IRR )
1 2
(1 + IRR ) n
n
Cˆ Ft
=∑ =0
t =0 (1 + IRR )
t

Accept-reject criterion

20
A project is acceptable if its IRR is greater than the firm’s required rate of
return. To solve the IRR we need the firms required rate of return. Taking of
a firm’s project’s whose IRR exceed its required rate of return, or cost of
funds, increases shareholders wealth.

Net Present Value Profiles (NPV profiles)

NPV profile is a curve showing the relationship between a project’s NPV
and various discount rate (required rate of return).

Profitability index (PI) or Benefit cost ratio (BC)

Yet another time adjusted capital budgeting technique is profitability index
(PI) or benefit -cost ratio (BC). It is similar to the NPV approach. The
profitability index approach measures the present value of return per TK
invested, while the NPV is based on the difference between the present value
of future cash inflows and the present value of cash outlays. A major
shortcoming of NPV method is that, being and absolute, measure, it is not a
reliable method to evaluate projects requiring different initial investment.
The PI method provides a solution to this kind of problem. It is, in other
wards, a relative measure. It may be defined as the ratio which is obtained
dividing the present value of future cash inflows by the present value of cash
outlays. Symbolically,

Present va lue of cash inflows

PI = Present va lue of cash out flows

This method is also known as the B/C ratio because the numerator measures
benefits and the denominator costs. A more appropriated description would
be present value index.

Accepted-rejected rules

Using the B/C ratio or the PI, a project will qualify for acceptance if its PI
exceeds one. When PI is equals one then the firm is indifferent to the

21
projects. When PI is greater than equal to or less than one, the net present
value is greater than, equal to or less than zero respectively. In other wards,
the NPV will be positive when the PI is greater than one, will be negative
when the PI is less than one. Thus, the NPV and PI approaches give the same
result regarding the investment proposal. The selection of projects with the
PI method can also be done on the basis of ranking. The highest rank will be
given to the project with the highest PI, followed by the others in the same
order.

3.3 CALCULATION OF PAYBACK PERIOD OF TWO PROJECTS

3.3.a Calculation of Pay back period of grinding machine

Number of years before
full recovery of initial
Payback period =
investment
Amount of investment
unrecovred at start of the the recovery year
+ Total cash flow generated during the recovery
year

2000
⇒5 + = 5.36
5600

Discounted payback period of grinding machine

At 10% discounting rate

Year Year
s
1 Cˆ F1 5600 11 Cˆ F11 5600
= = 509 = = 196
(1 + k ) 1
(1 + .10 )1 (1 + k ) 11
(1 + .10 ) 11
1 3
2 Cˆ F2 5600 12 Cˆ F12 5600
= = 4628 = = 178
(1 + k ) (1 + .10 ) 2
2
(1 + k ) 12
(1 + .10 ) 12
4
3 Cˆ F3 5600 13 Cˆ F13 5600
= = 4207 = = 162
(1 + k ) 3
(1 + .10 ) 3 (1 + k ) 13
(1 + .10 ) 13
2
4 Cˆ F4 5600 14 Cˆ F14 5600
= = 3825 = = 147
(1 + k ) (1 + .10 ) 4
4
(1 + k ) 14
(1 + .10 ) 14
5

22
5 Cˆ F5 5600 15 Cˆ F15 8600
= = 3477 = = 205
(1 + k ) 5
(1 + .10 ) 5 (1 + k ) 15
(1 + .10 ) 15
9
6 Cˆ F6 5600
= = 3161
(1 + k ) 6
(1 + .10 ) 6
7 Cˆ F7 5600
= = 2874
(1 + k ) 7
(1 + .10 ) 7
8 Cˆ F8 5600
= = 2612
(1 + k ) 8
(1 + .10 ) 8
9 Cˆ F9 5600
= = 2375
(1 + k ) 9
(1 + .10 ) 9
10 Cˆ F10 5600
= = 215
(1 + k ) 10
(1 + .10 )10
9

Discounted payback period of grinding machine

Amount of investment
Number of years before
+ + unrecovred at start of the the recovery year
= full recovery of initial +
investment Total cash flow generated during the recovery
year

125
= 8+ 2375

= 8.053

3.3. b Pay back period of stone crushing machine

Number of years before
full recovery of initial
Payback period =
investment
Amount of investment
unrecovred at start of the the recovery year
+ Total cash flow generated during the recovery
year

23
 5500
⇒5 + = 5.87
6300

Discounted payback period of S

At 10% discounting rate

Year Years
s
1 Cˆ F1 6300 10 Cˆ F10 6300
= = 572 = = 242
(1 + k ) 1
(1 + .10 )1 (1 + k ) 10
(1 + .10 ) 10
7 9
2 Cˆ F2 6300 11 Cˆ F10 6300
= = 520 = = 220
(1 + k ) (1 + .10 ) 2
2
(1 + k ) 10
(1 + .10 ) 11
7 8
3 Cˆ F3 6300 12 Cˆ F12 6300
= = 473 = = 200
(1 + k ) 3
(1 + .10 ) 3 (1 + k ) 12
(1 + .10 ) 12
3 7
4 Cˆ F4 6300 13 Cˆ F13 6300
= = 430 = = 182
(1 + k ) (1 + .10 ) 4
4
(1 + k ) 13
(1 + .10 ) 13
3 5
5 Cˆ F5 6300 14 Cˆ F14 6300
= = 391 = = 165
(1 + k ) 5
(1 + .10 ) 5 (1 + k ) 14
(1 + .10 ) 14
2 9
6 Cˆ F6 6300 15 Cˆ F15 10300
= = 355 = = 246
(1 + k ) 6
(1 + .10 ) 6 (1 + k ) 15
(1 + .10 ) 15
6 6

24
7 Cˆ F7 6300
= = 323
(1 + k ) 7
(1 + .10 ) 7
3
8 Cˆ F8 6300
= = 293
(1 + k ) 8
(1 + .10 ) 8
9
9 Cˆ F9 6300
= = 267
(1 + k ) 9
(1 + .10 ) 9
2

Discounted payback period of Stone Crusher

Number of years before Amount of investment

full recovery of initial unrecovred at start of the the recovery year
= investment + Total cash flow generated during the recovery
year

718
= 9+ 2429

= 9.30

3.4. CALCULATION OF NET PRESENT VALUE OF TWO MACHINES

3.4. a Calculation OF NET present value (NPV) of grinding machine

Net present value at 14% of RRR:

Cˆ F1 Cˆ F2  Cˆ Fn 
= Cˆ F  + + + .......... ... +  
(1 + k ) (1 + k )
1 2
 (1 + k )
n 

n
Cˆ Ft
= ∑(1 + k )
t =0
t

25
 5600 5600 5600 5600 5600 8600
= ( 30000 ) + + + + + + .......... .......... +
(1 + .14 ) 1
(1 + .14 ) 2
(1 + .14 ) 3
(1 + .14 ) 4
(1 + .14 ) 5
(1 + .14 ) 15

= (30000) + 34815

= 4815

Net present value of G at 18% of RRR:

Cˆ F1 Cˆ F2  Cˆ Fn 
= Cˆ F  + + + .......... ... +  
(1 + k ) (1 + k )
1 2
 (1 + k )
n 

n
Cˆ Ft
= ∑ (1 + k )
t =0
t

5600 5600 5600 5600 5600 8600

= ( 30000 ) + + + + + + .......... .......... +
(1 + .18 ) 1
(1 + .18 ) 2
(1 + .18 ) 3
(1 + .18 ) 4
(1 + .18 ) 5
(1 + .18 ) 15

= (30000) + 28767

= (1233)

3.4.b Calculation of Net present value (NPV) of Stone Crusher

Net present value at 14% of RRR:

Cˆ F1 Cˆ F2  Cˆ Fn 
= Cˆ F  + + + .......... ... +  
(1 + k ) (1 + k )
1 2
 (1 + k )
n 

n
Cˆ Ft
= ∑(1 + k )
t =0
t

6300 6300 6300 6300 6300 10300

= ( 37000 ) + + + + + + .......... .......... +
(1 + .14 ) 1
(1 + .14 ) 2
(1 + .14 ) 3
(1 + .14 ) 4
(1 + .14 ) 5
(1 + .14 ) 15

= (37000) + 39255

26
= 2255

Net present value at 18% of RRR:

Cˆ F1 Cˆ F2  Cˆ Fn 
= Cˆ F  + + + .......... ... +  
1
(1 + k ) (1 + k ) 2
 (1 + k )
n 

n
Cˆ Ft
= ∑(1 + k )
t =0
t

6300 6300 6300 6300 6300 10300

= ( 37000 ) + + + + + + .......... .......... +
(1 + .18 ) 1
(1 + .18 ) 2
(1 + .18 ) 3
(1 + .18 ) 4
(1 + .18 ) 5
(1 + .18 ) 15

= (37000) + 32416

= (4584)

3.5 CALCULATION OF INTERNAL RATE OF RETURN OF TWO PROJECTS

3.5. a Calculation of Internal rate of return (IRR) of Grinding

machine

NPV at lower rate

IRR = Percentage of lower rate + × Difference between rates
Difference between NPV' s

4815
= 14% + × 4%
4815 − ( −1233 )

= 17.18%

27
 3.5. b Calculation of Internal rate of return (IRR) of Stone Crusher
Machine

NPV at lower rate

IRR = Percentage of lower rate + × Difference between rates
Difference between NPV' s
2255
= 14% + × 4%
2255 − (−4584 )

= 15.32%

3.6 NPV PROFILE OF GRINDING MACHINE AND STONE CRUSHER MACHINE

28
 NP V p r o f ile f o r G r in d in g m a c h in e & S to n e c r u s h e r p r o je c t

65000
60000
55000
50000
45000
40000
35000
30000
G r i nd i ng mac hi ne ' s ( G ) N P V p r o f i l e
NPV $

25000
S t o ne c r us he r ' s ( S ) N P V p r o f i l e
20000
15000
10000
50 0 0
0
- 5 0 0 00 5 10 15 20 25

-10000
-15000
Dis c o u n t ( Re q u ir e d ) r a t e %

Maturity NPV G NPV S

0% 57000 61500
5% 29571 30318
10% 13311 11874
15% 3112 328
20% (3625) (7287)

This figure shows that, the NPV profile for Grinding machine (G) and Stone
crushing machine (S) decline as the discount rate increases. However, that
project S has the higher NPV at low discount rates, where as project G has
the higher NPV at high discount rates. According to the graph,
NPV G = NPV S = 25000 when the discount rate, k equals 6.5 percent. We call

29
this point the crossover rate because bellow this rate N G 〈 NP S PV V
, above this

rate, N PG 〉 NV PS -that
V is, the NPV G crossover rate at 6.5 percent.

The figure is also indicates that Stone crushing machine’s NPV is more
sensitive to change in the discount rate than is NPV G . That is, Stone crushing
machine’s net present value profile has the stepper slope, indicating that a
given change in k has a large effect on NPV S than on NPV G .

If Project G and Project S are mutually exclusive rather than independent,

then only one project can be accepted. We know, mutually exclusive
projects, is a set of project in which acceptance of one project means the
other cannot be accepted. If we use IRR to make the decisions as to which
project in better, we can choose Project G because I R G 〉RI R S ,R if we use NPV to
make the decision, we might reach a different conclusion depending on the
firm’s required rate of return. From the figure, if the required rate of return is
less than the crossover rate of 6.5 percent, N PS 〉 NV PG , Vand N PG 〉 NV PS Vif the
required rate of return is greater than 6.5 percent. As a result Project S would
be preferred if the firm’s required rate of return is less than 6.5 percent, but
the Project G would be preferred if the firm’s required rate of return is
greater than 6.5 percent.

As long as the firm’s required rate of return is greater than 6.5 percent, using
either NPV or IRR will result in a same decision- that is, Project G should
be purchased because N PG 〉 NV PS and
V I R G 〉RI R S .R On the other hand, if the firm’s
required rate of return is less than 6.5 percent, a person who uses NPV will
reach a different conclusion as to which project should be purchased. The
organization will choose the Project S because N PS 〉 NV PG .VIn this situation if
the required rate of return is less than 6.5 percent, there is a conflict exist
because NPV says choose Project S over Project G, where as IRR says just
the opposite.

30
 3.7 PROFITABILITY INDEX (PI) OR BENEFIT-COST RATIO (B/C RATIO) OF
THE TWO PROJECTS.

3.7 a Calculation for profitability Index of Grinding Machine

Present va lue of cash inflows

Profitability index of Grinding machine = Present va lue of cash out flows

34815
= 30000

= 1.16

3.7. b Calculation of profitability index for Stone Crusher Machine

Present va lue of cash inflows

Profitability index of Stone crusher machine = Present va lue of cash out flows

39255
= 37000
= 1.06

31
 3.8 COMMENTS ON THE OVERALL CALCULATION

3.8.1 Comments in respect of NPV:

These project (grinding machine & stone crusher) are mutually exclusive
projects. Here, NPV at 14% required rate of return of grinding machine is
4815 and NPV at 14% required rate of return of stone crusher is 2255.
We know that, if NPV is positive than the project is accepted other than it
will be rejected. If both project’s NPV are positive than the project of higher
NPV is accepted in mutually exclusive project.
Here the NPV of both projects is positive. But the NPV of Grinding machine
is higher than the NPV of stone crusher machine. So the company should
accept the first option that is- Grinding machine.

3.8.2 Comments in respect of IRR:

These projects (grinding machine & stone crusher) are mutually exclusive
projects. Here, IRR of grinding machine is 17.18% and IRR of stone crusher
is 15.32%.
We know that, if IRR is higher than the required rate of return (RRR) than
the project is accepted other than it is rejected. If both project’s IRR is
higher than the required rate of return than the higher IRR’s project will be
accepted.
Here the IRR of both projects is greater than the required rate of return. But
the IRR of Grinding machine is higher than the IRR of stone crusher. So the
company should accept the first option that is- Grinding machine.

3.8.3 Comments in respect of profitability index

Using the profitability index, a project will qualify for acceptance if its
profitability index exceeds one, when profitability index is equals 1, the firm
is indifferent to the project. When PI is greater than, equal to or less than 1,
the net present value is greater than, equal to or less than zero respectively.
In other words the NPV will be positive when the PI is greater than 1; will be
negative when the PI is less than 1.

32
In the Grinding and Stone crusher machine, the PI would be 1.16 for
Grinding machine; the PI would be 1.06 for Stone crusher machine.

Since the PI for both the machines is greater than 1, both the machines are
acceptable, but the company has to accept the project of greater profitability
index. Because, it shows greater net present value. In this case the Grinding
machine project is accepted.

33
 CHAPTER: 4
Summary, Conclusion &
Recommendation

34
 4.1 SUMMARY

PRAN-RFL group can determine the profitability measure of the two

projects with the help of above calculation. The both projects life time is
same; the salvage value is also same. But the purchase price of the Stone
crusher machine is higher than the Grinding machine. The production
capacity of two machines is also different. These two projects are in
existence in this current market. PRAN-RFL group should purchase
Grinding Machine between the two projects Grinding and Stone Crusher.
For recover the cost of machine, the Grinding machine is appropriate
because its pay back period is lower than the stone crusher machine. In case
of NPV, the NPV of Grinding machine and Stone crusher machine at 14%
required rate of return are both positive. But the NPV of grinding machine is
higher. For that reason, the PRAN-RFL group should purchase Grinding
machine in respect of greater NPV. In case of IRR, both machines IRR is
higher than required rate of return. But the Grinding machine possesses
higher IRR, for this, the PRAN-RFL group should purchase the Grinding
Machine. If the profitability index is higher than 1 then it indicates that, the
NPV is also higher. In case of both Grinding machine and Stone crusher
machine, the profitability index is higher than 1. But the profitability index
of Grinding machine is more higher than the Stone crusher machine. For the
entire situation, the PRAN-RFL group should purchase the Grinding
Machine.

35
 4.2 CONCLUSION

Forecasting in a profitable project is very much important to existence any

business in this competitive business market. It is needed to use various
machineries for conducting production activities of the company. For this the
company have to purchase various machineries, for this reason capital
budgeting is very much important for corporations. But if the firm invest too
much in assets, it will be incurred unnecessarily heavy expenses. And if it
does not spend enough on fixed assets, it might find that inefficient
production and inadequate capacity lead to lost sales that are difficult, if it is
not possible to recover. Timing is also important in capital budgeting,
Capital assets must be ready to come on line when they are needed;
otherwise, opportunities must be lost. Effective capital budgeting can
improve both the timing of assets acquisition and the quality of assets
purchased. A firm that forecast its needs for capital assets in advanced will
have an opportunity to purchase and installs the assets before they are
needed.

36
 4.3 RECOMMENDATION

1. For recover the cost of machine, the Grinding machine is appropriate

because its pay back period is lower than the stone crusher machine.
PRAN-RFL group should purchase Grinding Machine between the two
projects Grinding and Stone Crusher.

2. The NPV of grinding machine is higher. For that reason, the PRAN-RFL
group should purchase Grinding machine in respect of greater NPV.

3. In case of IRR, both machines IRR is higher than required rate of return.
But the Grinding machine possesses higher IRR, for this, the PRAN-RFL
group should purchase the Grinding Machine.

4. If the profitability index is higher than 1 then it indicates that, the NPV is
also higher for that project. In case of both Grinding and stone crusher
profitability index is more than 1. Here the company should purchase the
Grinding machine which profitability index is more higher.

5 If the firm invests too much in assets, it will be incurred unnecessarily

heavy expenses, for this reason the PRAN-RFL group should purchase the
Grinding Machine. Because it is less cost.

6. Which project pay back period is lower that project should be accept
because it indicates more capacity of recovery. In Grinding machine pay
back period is lower for this reason the company should purchase it.

37
 4.4 Bibliography

1. Besley Scott & Brigham Eugene F.; Essentials of Managerial Finance 13th
edition, Thomson South Western.
2. Van Horne James C. & Wachowicz John M.; Financial Management 11th
edition, Pearson Eucation Asia.
3. Khan M Y & Jain P K ; Financial Management 3rd edition, Tata Mc
Graw Hill Publishing Company ltd.

38