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Conceptual Qs:
1.
Payback Period and NPV: If a project with conventional cash flows has a payback period
less than the projects life, can you definitely state the algebraic sign of the NPV? Why or
Why Not? If you know that the discounted payback period is less than the projects life,
what can you say about the NPV? Explain.
2. NPV: Suppose a project has conventional cash flows and a positive NPV. What do you know
about its payback? Its discounted payback? Its profitability index? Its IRR? Explain.
Q1A. [Calculating the NPV]: Suppose Duke Co. has an investment that requires a
Rs.12 million cash outlay today. It estimates that the expected incremental CIFs
associated with this investment are Rs.5 million at the end of years 1 and 2 and
Rs.8 million at the end of year 3. Using a 15% discount rate, what is the projects
NPV? Explain the decision criteria for accepting or rejecting the project.
Q1B. [Calculating the NPV with different discount rates]:
Consider an
investment that requires an initial outlay of Rs.5 million, with expected CIFs
associated of Rs.1 million, Rs.0 million and Rs.5 million, respectively, for the
following 3 years.
(a)
(b)
(c)
Q2A. [Calculating the IRR]: Suppose Duke Co. has an investment that requires a
Rs.12 million cash outlay today. It estimates that the expected incremental CIFs
associated with this investment are Rs.5 million at the end of years 1 and 2 and
Rs.8 million at the end of year 3. What is the projects Internal Rate of Return or
IRR and compute it? Why IRR is called the Internal Rate of Return?, i.e., What is
the meaning of internal here? Explain the decision criteria for accepting or
rejecting the project on the basis of IRR. Assume the projects cost of capital is
15%.
Q2B. [Calculating the IRR]: Consider an investment that requires an initial outlay
of Rs.5 million, with expected CIFs associated of Rs.1 million, Rs.0 million and Rs.5
million, respectively, for the following 3 years. What is the IRR of this investment?
Whether to accept or reject this project on the basis of IRR, assuming the
projects cost of capital as 5%. If 8%?
Q3. [A Comprehensive Example]:The expected net cash flows of a project after
tax are as follows:
Year-end
1
2
3
4
5
6
The cost of capital is 12%. Calculate the followings: (a) Discounted Payback Period,
(b) Net Present Value, (c) Internal Rate of Return and (d) Modified Internal Rate
of Return.
Q4. [A Comprehensive Example]:
Project A is an extension of an existing line. Its cash flow will decrease over
time.
Project B involves a new product. Developing its market will take some time
entail a cost initially which will be followed by a huge benefit for one year.
However, in the year following that a substantial cost will be incurred to
raze the pavilion.
The expected net cash flows of the three projects are as follows.
Year
Project A
Project B
Project C
(15,000)
(15,000)
(15,000)
11,000
3,500
42,.000
7,000
8,000
(4,000)
4,800
13,000
___
Ravi Sharma believes that all the three projects have risk characteristics similar
to the average risk of the firm and hence the firm's cost of capital, viz. 12
percent, will apply to them.
You are asked to evaluate the projects.
Read the above case carefully and answer the following questions. Write the
most appropriate answer in the answer sheet. No need to show the
calculations.
1.
(d)
Data
inadequate
(approx.).
(a) 3,520, 3,432 and 18,745
(b) 4,123,
4,096
Year-end
1
2
3
4
5
The cost of capital is 8% for both projects. Calculate the followings: (a) NPV (b)
IRR
(c) PI or BCR (d) NPI or NBCR (e) PBP and (f) Discounted PBP and (g)
and IRR methods. Finally, in your opinion, which project should be accepted? Why?
Assume a 10% discount rate.
Q7. [Risk Analysis Mean-Variance Approach]: M/S XYZ Ltd. has under its
consideration a project with an initial investment of Rs.10,00,000/-. Three
probable cash inflow scenarios with their probabilities of occurrence have been
estimated as below :
Annual Cash Inflow (Rs.)
Probability
200,000
0.1
300,000
400,000
0.7
0.2
The project life is 5 years and the desired rate of return is 20%. The estimated
terminal values for the project assets under the three probability alternatives,
respectively, are Rs.0, Rs.200,000/- and Rs.300,000/-. You are required to :
(i)
(ii)
20,000
30,000
40,000
0.1
0.7
0.2
The projects life is 5 years and the desired rate of return is 20%. The estimated
terminal values for the project assets under the three probability alternatives,
respectively, are Rs.0, Rs.20,000/- and Rs.30,000/-. You are required to :
(a)
(b)
Q9. The Dixey Valley Company is considering two mutually exclusive projects with
different lives. The costs (cash flows) of the projects are given below:
C0
C1
C2
150
30
30
75
40
40
C3
30
C4
30
The discount rate is 10 per cent. Which project should be selected and why?
Q10. {Project Cash Flow Estimation]: Mr Palekar, Director (Finance) of Arrow
Synthetics Limited, and Mr Roy, Manager, Management Services Division of the
company were discussing about ways to improve the management information
system in the company. They concluded that they needed a better computer
system for the growing volume of information generated in the business. Mr Roy
enquired and found that Theta X system supplied by FT Ltd. was quite suitable for
the needs of their organization.
He estimated the costs and benefits associated with the system.
Rs 1.5 million
Rs 0.25 million per annum
Rs 0.6 million per annum
Rs 0.1 million per annum
The computer system would have an economic life of 5 years and it would be
depreciated at the rate of 33 percent per year as per the written down value
method. After five years, it would be disposed of for a value equal to its book
value. The tax rate is 50 percent. Mr. Roy requires your help to prepare projected
cash flows of the capital budgeting proposal. (In case there is a loss before tax, it
would provide a tax shelter)
You are also required to calculate the Net Present Value of the proposal assuming
a discount rate of 14 percent.