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an annalysis on investment building constuction

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Based on Time Value of Money

Benefit Cost Ratio

Net Present Worth or Net Present Value (NPV)

Internal Rate of Return (IRR)

Risk Analysis

Debt coverage Service Ratio (DCSR)

Cost-Benefit Analysis

Scientific criteria to evaluate projects

Determines the scale of the project on the basis of maximation of the

differences between benefit and cost

Cost-benefit analysis (CBA), or benefitcost analysis (BCA), is used to

assess benefits and costs of a project

Purpose of CBA is;

Determine if it is a sound investment/decision

Basis to compare projects.

Compares the total expected cost of each option against the total

expected benefits, to see whether the benefits outweigh the costs,

and by how much.

CBA focuses on economic efficiency

Calculates net benefits for each project

to describe and quantify the social advantages and disadvantages of the policy

in terms of a common monetary unit

3

B/C is ratio method used to evaluate the project

If B/C=1; the project is marginal.(i.e. just covering the costs)

If B/C>1; (Accepted) widely used in markets to reap maximum benefits

If B/C<1; (Rejected)

Evaluation of Benefits:

Benefits ------ increase income of the people --------Increase production &

consumption.

Real and Nominal Benefits : Real benefits play a vital role.

Improvement in irrigation - increase in productivity of land per acre economic benefits - income rises

Ex: Irrigation Project flood control, irrigation, development of fisheries, power etc

Employment, new road way, livelihood etc are some of the indirect benefits

Evaluation of Costs:

Project Cost, Associated Cost, Real & Nominal Cost , Direct and Indirect Cost,

Need of CBA

Recent government decisions give renewed focus to CBA

Agencies need to build their capacity to use CBA to improve the

quality of regulatory and financial analysis

Greater use of CBA expected by government for regulatory

proposals

Takes a community-wide perspective

Allows the consideration of a range of policy options

Determines which proposal maximises net benefits to the

community

Allows benefits and costs to be compared over time

Represents the costs and benefits accruing to different groups

within the community

6

In B/C Ratio, we try to assess how much of our

present costs and benefits are worth at a future

point of time.

The costs and benefits are discounted and

assessed for the present.

Rs.1000 today is not the same as it would be

five years from now.

Rs.1000 today would have to be something

more than Rs.1000 next year.

How much it should be depend upon the

premium we place on that Rs.1000.

In other words, how much we want to use it

for the present (present consumption) and

how much we want to use it in future?

Option 1

You have a proposal to build a 3 power generating station of

10 MW each costing 3 million. The expected life of the project

is 10 years, during which, there is adequate demand Site

available is perfectly suited

Expected life of project

Each 10 Mega Watt Plant costs

Accessories and Other costs

Initial Investment ( 3 power stations * each 10 MW cost +

accessories cost)

Over next 10 yrs expected revenue

Each year expected revenue

Incurring costs for 10 years

Incurring cost per year (O&M costs)

Total Cost (for DBFO) of the plant (Costs) (3*3+1+15)

Benefits for 10 years

Benefits> Costs

3 Power Plants

10 Years

3 million

1 million

10 million

35 million

3.5 million/annum

15 million

1.5 million/annum

25 million

35 million

Option 2

You have a proposal to build a 1 power generating station of 60

MW. The expected life of the project is 10 years, during which,

there is adequate demand Site available is perfectly suited

Expected life period

Each 60 Mega WattPlant costs

Accessories and Other O&M costs

Initial investment (1 * each 60 megawatt cost +accessories cost)

Over next 10 yrs expected revenue

each year expected revenue

Incurring costs for 10 years

Incurring cost per year

Total Cost for DBFO of the plant (Costs) - (1*13+2+20)

Benefits for 10 years

1

10

13

2

15

48

4.8

20

2

35

48

Power Plants

years

million

million

million

million

million/annum

million

million/annum

million

million

The total cost of the project is 100 invested in first two years. i.e.50, 50

The total benefits of the project is 175 in which payments are received

for the next three years i.e. 40, 60, 75 respectively. Life period of the

project is 5 years. Calculate CBR taking 10% as an DF and convey

whether Project is accepted or rejected.

Total

Total Costs benefits

Year 1

Discounting

@10%

NPW

NPW Costs Benefits

50

0.91

45.45

0.00

50

0.83

41.32

0.00

40

0.75

0.00

30.05

60

0.68

0.00

40.98

75

0.62

0.00

46.57

100

175

86.78

117.60

two years i.e. 175,125. The total benefits of the

project is 600 in which payments are received for

the next three years i.e. 150, 200, 250 respectively.

Life period of the project is 5 years. Calculate CBR

taking 10% as an DF and convey whether Project is

accepted or rejected.

Present value

The current worth of a future sum of money or

stream of cash flows given a specified rate of return

Future cash flows are discounted at the discount

rate, and the higher the discount rate, the lower the

present value of the future cash flows

Present value, also known as present discounted

value

Used to make comparisons between cash flows

13

Present Value

To calculate the present value of any future

amounts

Single amount

Varying amounts

Annuities

1) PV = FV (1 + i)-n

(or)

2) PV = FV x [ 1 (1 + i)n ]

PV = Present value

FV = Future Value

i= rate of interest

n= number of years

14

1) Calculate the present value (the value at time period) of receiving a single amount of

1,000 in 20 years. The interest rate for discounting the future amount is estimated at

10% per year compounded annually.

PV= ??

FV= 1,000

.....

1 year

0

1 year

1

1 year

2

1 year

3

19

20

years is the equivalent of receiving 148.64

today, if the time value of money is 10% per

year compounded annually.

15

Method 1:

PV = FV (1 + i)-n

16

Calculation 2

Calculate the present value of a single amount

of 1,00 at the end of 2 years assuming the

interest rate of 8% per year compounded

annually.

17

Calculation 3

What is the present value of receiving a single amount of 5,000

at the end of three years, if the time value of money is 8% per

year, compounded quarterly

PV= ??

FV= 5,000

.....

3 months

3 months

3 months

3 months

11

12

PV = 3,942.45

18

Future Value

Value of an asset or cash at a specified date in the

future that is equivalent in value to a specified

sum today

Two ways of calculating future value:

Simple interest

For an asset with simple annual interest = Original

Investment x (1+(interest rate*number of years))

Compound interest

For an asset with interest compounded annually=

Original Investment x ((1+interest rate)^number of

years)

19

FV= PV*(1+rt)

PV=Present value

R= rate of interest

T= time period

interest of 10% what will be the future value?

20

Interest)

1000 invested for 5 years with compounded

annual interest of 10% what will be the future

value?

FV= PV*(1+i)t

PV=Present value

i= rate of interest

t= time period

= 1000*(1+0.10)5

= 1000*(1.10)5

= 1000*(1.610)

=1610.51

21

Annuities

Annuities - series of fixed payments required from

you or paid to you at a specified frequency over

time period.

Payment frequencies - Yearly, Semi-annually (twice

a year), Quarterly and Monthly.

There are two basic types of annuities:

Ordinary annuities : Payments are required at the end of each period.

Future Value

Present Value

22

To determine today's value of a future payment

Calculates the PV of the payments that you will receive in the

future.

Investing 1000 per year for the next 5 years, and investing that at

the 5%

Present value of an ordinary annuity returned a value of 4,329.48.

The present value of an ordinary annuity is less than that of an

annuity due because the further back we discount a future

payment, the lower its present value

23

Future value of an ordinary annuity formula To find out how much you

would have in the future by investing at your given interest rate..

Making payments on a loan, the future value is useful in determining the

total cost of the loan.

Investing 1000 per year for the next 5 years, and investing that at the 5%

i=Interest rate

n = Number of payments

Calculate the future value of each cash flow. Let's assume that you are

receiving 1,000 every year for the next five years, and you invested each

payment at 5%. (C*(1+r)^n (0-4))

Gives an accurate value

This means that if you could get a return on your invested funds of 5% per

year, receiving 5525.63.

24

Net Present Value (NPV):The sum of the present values

of all cash inflows minus the sum of the present values of

all cash outflows.

Appreciates time value of money

Only cash profits are important

Additive method

Provides a direct link between management decision and

shareholder value

first two years. The total benefits of the project is 175 in which

payments are received for the next three years i.e. 40, 60, 75

respectively. Life period of the project is 5 years.

Total Total

Discounting Net

Discounting

Year 1 Costs benefits @10%

benefits NB @10%

1

50

0

0.91

-50

-45.45

2

50

0

0.83

-50

-41.32

3

0

40

0.75

40

30.05

4

0

60

0.68

60

40.98

5

0

75

0.62

75

46.57

100

175

75

117.60

NPV = 30.83???

The internal rate of return (IRR): The rate at

which the sum of discounted cash inflow equals

the sum of discounted cash out flow.

In other words, it is the rate which discounts the

cash flow to zero.

The internal rate of return measures the

investment yield.

27

The acceptance and rejection is done base on

the IRR rate

NPV

It takes interest as a known factor

It calculates the exact amount of

investment (represents in currency)

Generates different results where

discount rates are applicable

IRR

It takes interest as a unknown factor

It calculates the maximum rate of

interest (represents in percentage terms

It gives predictions

IRR is a parameter that can be used to

If NPV>0, then project is accepted in rank several projects. The higher the IRR

nature

the most desirable is the project.

28

How to Assess

the Internal Rate of Return ?

At what rate the project is profitable?

For this we use the Internal Rate of Return

It is that rate which makes the NPV=0 and the

B/C Ratio =1

IRR represents the average earning power of

money used in the project over the project

life.

Net

DF

NPV

DF

NPV

DF @

NPV

Year Costs Benefits Benefits @10% @10% @25% @25% 19.00% @19%

150

-150

0.91 -136.36

0.80 -120.00

0.84 -126.05

25

20

0.83

16.53

0.64

12.80

0.71

14.12

50

45

0.75

33.81

0.51

23.04

0.59

26.70

75

70

0.68

47.81

0.41

28.67

0.50

34.90

125

120

0.62

74.51

0.33

39.32

0.42

50.28

170

275

105

172.66

103.83

126.02

IRR = {(Lower Discount Rate) + (Difference between

Higher and lower discount rate)} * [NPV at lower

Discount rate/Absolute difference between NPV

At two discount Rates that is total NPVs

= (10) + 15 * ( 0.69) = 10+10.35

= 20.35%

we compare that with that of the market rate of

interest.

If the market rate of interest is above this, the

project is rejected.

If it is below this , the project is selected.

Uncertainties Difficult to incorporate in to

project design just because it is uncertain.

Risks We can take measures to minimise

this.

Risk measurements are very well developed

now.

Risk Analysis

Here we concentrate only on three issues:

Variations in Benefits How much can we

tolerate without dropping a project?

Variations in Costs - How much can we

tolerate without dropping a project?

How much delay the project can afford?

Risk Analysis

Present value of benefits PV of Costs

Variations in Benefits = -----------------------------------------------------Present Value of Benefits

Variations in Costs = -----------------------------------------------------Present Value of Costs

Present value of Costs

Variations in time = -----------------------------------------------------Present Value of Benefits

Risk Analysis

9400 4206

Variations in Benefits = ------------------------- = 55%

9400

9400 - 4206

Variations in Costs = -------------------- = 123%

4206

4206

Variations in time = ----------------- = 0.45

9400

Using a 10% discount factor, this 0.45 is equivalent to 8 years.

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