ASSIGNMENT A

QUESTION ONE
YEAR
1 New Machine Cost

(22.00)

2 Annual Revenue

5.00

5.00

5.00

5.00

5.00

3 Decrease in operational Costs

1.10

1.10

1.10

1.10

1.10

(3.17)

(1.90)

(1.14)

2.93

4.20

4.96

(0.59)

(0.84)

(0.99)

2.34

3.36

3.97

4 Depreciation (W1)

(8.80)

5 Profit Before Tax (PBT)

(2.70)

6 Tax 20%

0.54

7 Profit After Tax (PAT)

8 Net Salvage: Old Machine
9

Net Salvage: New Machine

10

Initial Investment(1)

(2.16)
6.00

(5.28)
0.82
(0.16)
0.66

6.00
(22.00)

11 Operating Cash In-flows (7+4)

6.64

12 Terminal Cash Flows (8+9)

6.00

5.94

5.51

5.26

5.11
6.00

13 Net Cash Flow(10+11+12)

14 Discount Factor @ 17%

(22.00)
1.00

12.64
0.855

5.94 5.51
5.26
11.11
0.731
0.624
0.534
0.456

15 Present Value
16 Net Present value

(22.00)

10.81
4.46

4.34

3.44

2.81

5.07

Precision Engineering Ltd should replace the old machine with the new machine. The positive net
present value shows that the new machine will add value to the firm.

Note 1
Year
0 Investment
1 Depreciation @40%
Writing Down Value (WDV)
2 Depreciation @40%
Writing Down Value (WDV)
3 Depreciation @40%
Writing Down Value (WDV)
4 Depreciation @40%
Writing Down Value (WDV)
5 Depreciation @40%
Writing Down Value (WDV)

22.00
(8.80)
13.20
(5.28)
7.92
(3.17)
4.75
(1.90)
2.85
(1.14)
1.71

QUESTION TWO
a. The cash flows for investment proposal from the long term funds point of view are cash flow
streams which reflect the contributions made and benefits receivable by equity shareholders for
the use of funds from long term lenders. They are divided into 3 components:
Initial Investment: Long Term funds committed to the Project; Fixed Assets + Working Capital
Margin
Operating Cash Flows: Profit after Tax (PAT) + Depreciation + Other Non-Cash charges +
Interest on Term Loans (1-TR)
Terminal Cash Flow: Net Salvage Value of Fixed Assets + Net Recovery of Working capital
Margin

b.
YEAR

1
2

1 Total Funds Invested

2 Revenue

(1,390.00
)
1,000.00

1,200.00

3 Cost of Production
4 Depreciation(W1) (i) Buildings

(700.00)
(4.00)

(ii) Plant and machinery @ 33%

(iii) other fixed assets @33%
5 Interest: (i) Term Loan @16%
(ii) Bank Loan @ 18%
6 Profit Before Tax (PBT)
7 Tax 30%
8 After Tax (PAT)
9 Preferred Dividends
10 PAT & Preferred Dividends
11 Salvage: Plant and Machinery
: Other Fixed assets
: Land
:Building
12 Net Salvage Value of W/Capital
13 Repayment of Term Loan
14 Repayment of Bank Loan

(165.00)
(33.00)
(48.00)
(61.20)
(11.20)
3.36
(7.84)
(7.84)

15 Initial Investment(1)
16 Operating Cash In-flows [10+4+5(1T)]
17 Terminal Cash Flows
[11+12+13+14]

(840.00)
(4.00)

1,500.00
(1,050.00
)
(4.00)

1,500.00
(1,050.00
)
(4.00)

1,500.00
(1,050.00
)
(4.00)

(110.55)
(22.11)
(48.00)
(61.20)
114.14
(34.24)
79.90
(30.00)
49.90

(74.07)
(14.81)
(48.00)
(61.20)
247.92
(74.38)
173.54
(30.00)
143.54

(49.63)
(9.93)
(48.00)
(61.20)
277.24
(83.17)
194.07
(30.00)
164.07

(0.76)
(20.15)
(48.00)
(61.20)
315.89
(94.77)
221.12
(30.00)
191.12
100.00
80.00
100.00
450.00
(300.00)
(340.00)

259.72

309.59

300.79

289.20

(1,390.00
)
0 267.32

90.00

18 Net Cash Flow[15+16+17]

19 Discount Factor @ 20%

(1,390.00
)
1.000

267.32
0.833

259.72
0.694

309.59
0.579

300.79
0.482

379.20
0.402

20 Present Value

(1,390.00
)

222.68

180.25

179.25

144.98

152.44

21 Net Present value

(510.40)

WORKINGS
Depreciation: i) Plant and Machinery
YEAR Investment
1 Depreciation @33%
Writing Down Value (WDV)
2 Depreciation @33%
Writing Down Value (WDV)
3 Depreciation @33%
Writing Down Value (WDV)
4 Depreciation @33%
Writing Down Value (WDV)
5 Balancing Charge
Writing Down Value (WDV)

500.00
(165.00)
335.00
(110.55)
224.45
(74.07)
150.38
(49.63)
100.76
(0.76)
100.00

YEAR Investment
1 Depreciation @33%
Writing Down Value (WDV)
2 Depreciation @33%
Writing Down Value (WDV)
3 Depreciation @33%
Writing Down Value (WDV)
4 Depreciation @33%
Writing Down Value (WDV)
5 Balancing Charge
Writing Down Value (WDV)

100.00
(33.00)
67.00
(22.11)
44.89
(14.81)
30.08
(9.93)
20.15
(20.15)
0.00

ii) Other Fixed Assets

iii) Building 4% of acquisition cost on straight line is Rs.4 per year

c. To calculate the Internal Rate of Return (IRR)we estimate the second value of the NPV at a
lower discount rate say 10% and use the interpolation formula to calculate the IRR

NPV at 10% discount rate will be

15 Initial Investment
(1,390.00)
16 Operating Cash In-flows [10+4+5(1-T)] 0
267.32
259.72
17 Terminal Cash Flows [11+12+13+14]
18 Net Cash Flow[15+16+17]
(1,390.00) 267.32
259.72
19 Discount Factor @ 10%
1.000
0.909
0.826
20 Present Value
(1,390.00) 242.99
214.53
21 Net Present value
(243.47)
Extracted from 2(b) above but with new discount factor of 10%

IRR=L+[

309.59

300.79

309.59
0.751
232.50

300.79
0.683
205.44

NPV L
](HL)
NPV L NPV H

Where IRR= Internal rate of Return

L= Lower Discount Rate (10%)
H= Higher Discount Rate (20%)
NPV L = Net Present Value at a Lower Rate 243.47
NPV H

= Net Present Value at a Higher Rate -510.40 (in b. above)

IRR=10 +[

243.47
](20 10 )
243.47(510.40 )

IRR=10 +[

243.47
](10 )
243.47+ 510.40

IRR=10 +[

243.47
](10 )
266.93

IRR=10 +(0.91 10 )

289.20
90.00
379.20
0.621
251.07

IRR=10 9.1
IRR=0.9

d. With the discount factor of 20% the project gives a negative net present value. Matrix Pharma
Ltd should not go ahead with the proposed investment.
If additional cash flow of Rs. 5 Crores arises by disposing off the project then the terminal cash
flows would go up by Rs. 5 Crores. The new NPV would therefore be as follows

15 Initial Investment

(1,390.00)

16 Operating Cash In-flows [10+4+5(1T)]

259.72

309.59

300.79

(1,390.00) 267.32

259.72

309.59

300.79

1.00

0.694

0.579

0.483

879.20
0.40
2

180.25

179.25

145.28

353.44

17 Terminal Cash Flows [11+12+13+14]

18 Net Cash Flow[15+16+17]
19 Discount Factor @ 20%
20 Present Value

289.2
0
590.0
0

267.32

0.833

(1,390.00) 222.68

(309.10
)
Extracted from 2(b) above with addition of 500 to terminal cash flows

21 Net Present value

The project would still not be worthwhile because the project NPV is still negative. Matrix Pharma Ltd
should still not go ahead with the investment

QUESTION THREE
a.
Year 1
CF
800
600
400
200

P
0.1
0.2
0.4
0.3

Mean

Year 2
CF P

80
120
160
60
420

CF
800
700
600
500

Year 3
CF P

P
0.1
0.3
0.4
0.2

CF
1200
900
600
300

CF P

80
240
210
450
240
120
100
30
630
840
CF P=Cash flow multiplied by Probability

CF= Cash flow, P= Probability and

Determination of expected NPV

Present Value Factor
Year
Mean Cash flows
@5%
1
420.00
0.952
2
630.00
0.907
3
840.00
0.864
Total Present Value Cash inflows
Less cash Outflows
NPV

b.

P
0.2
0.5
0.2
0.1

Total Present
Value
399.84
571.41
725.76
1,697.01
(1,500.00)
197.01

YEAR 1

(CFCF)

2
(CFCF)

(800420)

380 =144,400

144,400 0.1=14, 440

(630420)

2102=44,100

44, 100 0.2=8,820

2 P
(CFCF)

(400420)

20 2=400

400 0.4=160

(200420)

2202=48, 400

48, 400 0.3=14520

2P
(CFCF)

37,940.00

37,940.00=194.78

YEAR 2

(CFCF)

)2
(CF CF

(800630)

170 =144,400

28, 900 0.1=2, 890

(700630)

702=44,100

4, 900 0.3=1, 470

(600630)

30 2=400

900 0.4=360

(500630)

1302=48, 400

16, 900 0.2=3, 380

2 P
(CFCF)

8100.00

2P
(CFCF)
2

8100.00=90

YEAR 3

(CFCF)

)2
(CF CF

)2 P
(CFCF

(1200840)

3602=129,600

129600 0.2=25, 920

(900840)

60 =3, 600

3,600 0.5=1, 800

(600840)

240 2=57,600

57,600 0.2=11, 520

(300840)

5402=291, 600

291,600 0.1=29,160

)2 P
(CFCF

68, 400.00
8

68400.00=261.53

NPV =

12
22
32
+
+
( 1+i)2 (1+i)2 (1+i)2

NPV =

37940
8100
68400
+
+
2
2
(1+ 0.05) (1+0.05) (1+0.05)2

NPV =

37940 8100 68400

+
+
1.1025 1.1025 1.1025

NPV =103800.4535
NPV =322.18

c. The probability that the NPV will be Zero or Less

X NPV
Z = NPV
NPV
Z=

0197.01
322.18

Z =0.61

From the Z table

P ( Z 0.61 )=0.270927.09
QUESTION FOUR
Domestic Prices
Rs.
Rs.

Tradable Inputs

Raw materials (world Price ( 600 1.25 )

700
150

Consumables
Total
Non Tradable Inputs
Other overheads
Repairs and Maintenance

World Prices
Rs.
Rs.
750
200

850
100
44
9

950
100
44

Adminstrative overheads
Selling Overheads
Total
Total Inputs
Sales realization

110
60

Value Added

110
60
314
1164
1500

314
1264
1500

336

236

Effective Rate of Protection( ERP)

ERP=

Value Added at Domestic priceValue Added at World Price

100
Value Added at world Price

ERP=

336236
100
236

ERP=

100
100
236

ERP=0.42 100
ERP=42

Domestic resource Cost (DRC)

DRC=( ERP+ 1 ) Exchange Rate
DRC=( 0.42+1 ) Rs .45
DRC=1.42 Rs .45
DRC=Rs . 63.90

10

The effective rate of protection (ERP) of 42% means that the value added at domestic prices to
manufacture spices would have been higher by 42% if the price of imported inputs were not distorted
through policy intervention of 25% tariff. The Domestic resource cost of Rs.63.90 is the spending
required by M/S Global Spices to generate a saving of $1. The ERP assumes that the domestic prices
and the world prices are not equal

QUESTION FIVE
A preliminary appraisal involves an initial specification of the nature and objectives of the project and
of relevant background circumstances economic, social and legal). Format of Preliminary Appraisal
In terms of format a preliminary appraisal should include a clear statement of the needs which a project
is designed to meet and the degree to which it would aim to meet them. It should identify all realistic
options, including the option of doing nothing and, where possible, quantify the key elements of all
options. It should contain a preliminary assessment of the costs and gains of all options choose the
preferred one and make a judgement on whether its gains (the net present value) are sufficient to
warrant incurring its costs.
On the basis of the preliminary appraisal, the Sponsoring company or government agency should
decide whether formulating and assessing a detailed appraisal would be worthwhile or whether to drop
the project. A recommendation to undertake a detailed appraisal should state the terms of reference of
that appraisal

ASSIGNMENT B
QUESTION ONE.
In the question the decision variables will be

X 1, X 2 , X 3, . , X 10

Additionally, two other decision variables are required as follows:

X 11 is the decision variable to represent the delay of project 2 by one year.

11

X 12

is the decision variable that represents the combination of projects 3 and 7.

X 12

will be as

follows:
Project

Cash outflow
(Year 1)
37.8
[90%of (23+19)]

X 12

Cash outflow
(Year 2)
65.7
[90%of (28+45)]

Cash outflow
(Year3)
10.8
[90%of (5+7)]

NPV
38.1
[112%of (20+14)]

The integer linear programming model will be developed as follows:

Maximise:
12 X 1+ 19 X 2+ 20 X 3+ 22 X 4 +10 X 5 +32 X 6 +14 X 7+ 24 X 8 +9 X 9+ 15 X 10+ 9.5 X 11 +38.1 X 12
Subject to:
20 X 1 +25 X 2 +23 X 3 +30 X 4+ 34 X 5 +38 X 6 +19 X 7+12 X 8+10 X 9+ 6 X 10 +0 X 11 +37.8 X 12 150
40 X 1 +35 X 2+28 X 3+24 X 4 + 21 X 5 +26 X 6 +45 X 7 +20 X 8+ 33 X 9 +44 X 10+ 25 X 11 +65.7 X 12 200
0 X 1 +0 X 2 +5 X 3 + 4 X 4 +0 X 5 +10 X 6 +7 X 7+ 35 X 8 +10 X 9 +9 X 10 +35 X 11 +10.8 X 12 80
Project interrelationships

a. Of projects 3, 4 and 8, at most two can be accepted.

X8 X3+ X4

b.

Projects 5 and 9 are mutually exclusive.

X5+ X 9 1

c.

Project 6 cannot be accepted unless both projects 1 and 10 are accepted.

2 X 6 X 1+ X 10

d.

Project 2 can be delayed by a year. Though the cash flows required will be the same, the net
present value will drop by 50%.
X 2 + X 11 1
12

e. Projects 3 and 7 are complimentary. If the two are accepted together, the total cash flows will be
reduced by 10% and net present value will be increased by 12%.
X 3 + X 7+ X 12 1

QUESTION TWO
Why Conflicts arise between two or more mutually exclusive projects? Analyse the situations
where conflicts may arise and suggest how these conflicts can be resolved.

Mutually exclusive projects are projects in which acceptance of one project excludes the others from
consideration. In such a scenario the best project is accepted. Net Present Value (NPV) and Internal
Rate of Return (IRR) conflict, which can sometimes arise in case of mutually exclusive projects,
becomes critical. The conflict either arises due to the relative size of the project or the cash flow pattern
of the projects may differ. That is, the cash flows of one project may increase over time, while those of
others may decrease or vice versa. Still conflict arises because projects may have different expected
lives.
According to Brigham and Ehrhardt (2008:386) when either timing or size differences are present, the
firm will have different amounts of funds to invest in the various years, depending on which of the two
or more mutually exclusive projects it chooses. For example if one project costs more than the other,
then the firm will have more money at time

t=0

to invest elsewhere if it selects a smaller project.

Similarly for projects of equal size one with larger early cash inflows provides more funds for
reinvestment in the early years. Given this situation the rate of return at which the funds should be
reinvested is a critical issue. The NPV and IRR methods give conflicting ranking to mutually exclusive
projects. In the case of independent projects ranking is not important since all profitable projects can be
accepted. Ranking of projects, however, becomes crucial in the case of mutually exclusive projects.
Since the NPV and IRR rules can give conflicting ranking to projects, one cannot remain indifferent as
to the choice of the rule. The NPV method implicitly assumes that the rate of return at which cash flows
can be reinvested is the cost of capital whereas IRR method assumes that the firm can reinvest at the
IRR. The best assumption is that the projects cash flows can be reinvested at the cost of capital, which
13

means that the NPV method is more reliable. Brigham and Ehrhardt (2008:387) assert that when
evaluating mutually exclusive projects especially those that differ in size and timing, the NPV should
be used.

QUESTION THREE
1. Write a note on lending norms and policies of the institutions.
Prudent management and administration of financial institutions including establishment of sound
lending norms and policies are of vital importance if the institutions are to be continuously operated in
an acceptable manner. Lending norms and policies should be clearly defined and set forth in such a
manner as to provide effective supervision by the directors and senior officers. The board of directors
of every financial institution has the legal responsibility to formulate lending norms policies and to
supervise their implementation. Therefore supervisors of financial institutions such as the central
institutions should encourage establishment and maintenance of written, up to date lending norms and
policies which have been approved by the board of directors. These norms and policies should not be a
static document, but must be reviewed periodically and revised in the light of changing circumstances
surrounding the borrowing needs of the customers as well as changes that may occur within the
institution itself. To a large extent, the economy of the community served by the institution dictates the
composition of the loan portfolio. The widely divergent circumstances of regional economies and the
considerable variance in characteristics of individual loans preclude establishment of standard or
universal lending policies. There are, however, certain broad areas of consideration and concern that
should be addressed in the lending policies of all institutions regardless of size or location. These
include the following, as minimums:
General fields of lending in which the institution will engage and the kinds or types of loans
within each general field;
Lending authority of each loan officer;
Lending authority of a loan or executive committee, if any;
Responsibility of the board of directors in reviewing, ratifying, or approving loans;

14

 Guidelines under which unsecured loans will be granted;

Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;
Limitations on the amount advanced in relation to the value of the collateral and the
documentation required by the institution for each type of secured loan;
Guidelines for obtaining and reviewing real estate appraisals as well as for ordering
reappraisals, when needed;
Maintenance and review of complete and current credit files on each borrower;
Appropriate and adequate collection procedures including, but not limited to, actions to be taken
against borrowers who fail to make timely payments;
Limitations on the maximum volume of loans in relation to total assets;
Limitations on the extension of credit through overdrafts;
Description of the institution's normal trade area and circumstances under which the institution
may extend credit outside of such area;
Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and
cover the institution's plans for monitoring and taking appropriate corrective action, if deemed
necessary, on any concentrations that may exist;
Guidelines addressing the institution's loan review and grading system (Watch list);
Guidelines addressing the institution's review of the Allowance for Loan and Lease Losses
(ALLL); and
Guidelines for adequate safeguards to minimize potential environmental liability.

15

The above are only as guidelines for areas that should be considered during the loan policy evaluation.
Management should develop specific guidelines for each lending department or function.

CASE STUDY
Appraising a project means reviewing and evaluating the project for feasibility and cost-effectiveness.
It involves understanding and approving the project concept, which explains what problem or need, is
to be addressed and what solution is required to implement it. This Project Appraisal process is
designed to help Andhra Pradesh, a new company incorporated recently and in the process of setting up
a 10 million tons per annum capacity cement project, to assess and justify the viability of this proposed
investment. Appraisal process involves a careful checking of the basic data, assumptions and methodology
used in project preparation, an in-depth review of the work plan, cost estimates and proposed financing, an
assessment of how the project will be organized and management aspects and finally the viability of
project.
It is mandatory for the Andhra Pradesh Company to undertake project appraisal or at least give details of
financial, economic and social benefits of the Cement plant. On the basis of such an assessment, a
judgement will be reached as to whether the 10 million tons per annum capacity cement project is
technically sound, financially justified and viable from the point of view of the economy as a whole.
The starting point for appraisal is that Andhra Pradesh Company should provide a detailed description
of the project, stating clearing the local and even international needs for cement the company aims to
meet. Appraisal helps show if the project is the right response and highlight what the project is
supposed to do and for whom. The appraisal should help show that a project is consistent with the
objectives of the relevant funding program and with the aims of the local partnership. The appraisal will
help make links between Andhra Pradesh Company project and other local programs and projects.

16

Local consultation may help determine priorities and secure community consent and ownership. More
targeted consultation, with potential project users, may help ensure that project plans are viable. A key
question in appraisal will be whether there has been appropriate consultation and how it has shaped the
project. Options analysis is concerned with establishing whether there are different ways of achieving
objectives. This is a particularly complex part of project appraisal, and one where guidance varies. It is
vital though to review different ways of meeting local need and key objectives.

Project appraisal process includes technical, economic, financial, social and environmental analyses.
Technical analysis of a project is aimed at ensuring the following:
To confirm the source of the project proposal, nature of the studies including feasibility
studies undertaken before the proposal and the nature of decisions taken by all relevant
authorities involved
That the problem or the need to be resolved by the project has been clearly stated.
That the project has been clearly spelled out with the correct technical design details such as
size, location, timing and technology
That the required materials have been correctly determined and their source identified
That the costs of the project have been clearly established, expected product prices projected
and payment modalities and schedules agreed to.
The economic appraisal gives the costs and benefits of a project these costs and benefits are estimated
through the application of profitability tools like Net Present Value (NPV), internal rate of return (IRR),
Pay Back Period and Incremental Profit are used to estimate the viability of the project.
Financial Analysis takes a hard look at the funding sources for the project both in terms of completing
the project and for its sustained operation. This analysis should question if;
The Andhra Pradesh Company would fund the project from internal resources?
The Andhra Pradesh Company would fund the project from external resources?
The external resources would be borrowed funds?
If the funds are to be borrowed, would the Andhra Pradesh Company be able to pay back the
loan with accrued interest?
Would the external resources be a grant from the central government or from any other source?
17

 Would the Andhra Pradesh Company co-fund the project with an outside donor, whether it is a
central government or another development partner?
Would effective cost recovery mechanisms aimed recouping the project costs be put in place?
Would financial management modalities be put in place to record the transactions during
implementation and operation of the project? Documents could include cashbook, assets
register, bank statements, balance sheet (accruals accounting), income statements (or receipt
and payment schedules).
The Environmental Analysis is aimed at ensuring that the project complies with the various
environmental requirements as administered by the host country such as the Environmental Resource
Management (EMA). Specifically, the project should comply with the provisions of the National
Environment Statute and the Environmental Impact Assessment. Environmental aspects that projects
would have to address include;
Public health and occupational safety
Control of air, water and land pollution
Management of renewable natural resources (plants and animals)
Efficient use of natural resources through multiple use, recycling and erosion control
Conservation of unique habits (forests, game reserves) for rare species and cultural preservation
The validity of the planners assumptions about the social conditions is tested through social analysis.
Where necessary, adjustments should be made so that the project goals are expressed in terms that have
more meaning for both the project population and the implementing agencies. Social analysis focuses
on four areas indicated below;
The social-cultural and demographic characteristics of the project population its size and
social structure, including ethnic, tribal and class composition
How the project population has organized itself to carry out productive activities, including the
structure of households and families, availability of labour, ownership of land and access to and
control of resources
The projects cultural acceptability; in other words, its capacity both for adapting to and for
bringing about desirable changes in peoples behaviour and in how they perceive their needs

18

 The strategy necessary to elicit commitment from the project population and to ensure their
sustained participation from design through to successful implementation, operation and
maintenance
When the project appraisal is done and report is compiled it is then submitted to the senior management
for review and approval. The managers review the appraisal and in case there are any
misunderstandings or gaps in the appraisal they can return the document back for revising. When all the
revisions and corrections are done, the document is approved and signed off and the project steps to the
next phase - Planning.

ASSIGNMENT C (MULTIPLE CHOICE)

1
2
3
4
5
6
7
8
9
10

D
E
C
E
E
D
B
A
D
B

11
12
13
14
15
16
17
18
19
20

C
A
D
D
A
C
B
E
D
B

21
22
23
24
25
26
27
28
29
30

19

A
E
B
C
A
D
E
A
B
C

31
32
33
34
35
36
37
38
39
40

A
E
E
D
E
C
C
A
A
E

Bibiliography
Barker R. (2001), Determining value, Valuation Models and Financial Statements. Harlow: financial
Times Prentice Hall.
Brigham E. and Ehrhardt M. (2008), Financial Management: Theory and Practice. USA: Thomson
Learning Inc.
Khani M.Y. and Jain P.K. (2007), Basic Financial Management, second edition, New Delhi: Tata Mc
Graw-Hill Publishing Company Limited.

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