Professional Documents
Culture Documents
∑TY–nTY
b=
∑T2–nT2
a = Y – bT
The parameters are calculated below:
Calculation in the Least Squares Method
T Y TY T2
1 2,000 2,000 1
2 2,200 4,400 4
3 2,100 6,300 9
4 2,300 9,200 16
5 2,500 12,500 25
6 3,200 19,200 36
7 3,600 25,200 49
8 4,000 32,000 64
9 3,900 35,100 81
10 4,000 40,000 100
11 4,200 46,200 121
12 4,300 51,600 144
13 4,900 63,700 169
14 5,300 74,200 196
2
∑ T = 105 ∑ Y = 48,500 ∑ TY = 421,600 ∑ T = 1,015
T = 7.5 Y = 3,464
57,880
= = 254
227.5
a = Y – bT
= 3,464 – 254 (7.5)
= 1,559
Thus linear regression is
Y = 1,559 + 254 T
2. In general, in exponential smoothing the forecast for t + 1 is
Ft + 1 = Ft + α et
1 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Period t Data (St) Forecast Error Forecast for t + 1
(Ft) (et St =Ft) (Ft + 1 = Ft + α et)
1 2,000
2 2,200
3 2,100 F4 = (2000 + 2200 + 2100)/3 = 2100
4 2,300 2100 F5 =(2200 + 2100 + 2300)/3= 2200
5 2,500 2200 F6 = (2100 + 2300 + 2500)/3 = 2300
6 3,200 2300 F7 = (2300 + 2500 + 3200)/3= 2667
7 3,600 2667 F8 = (2500 + 3200 + 3600)/3 = 3100
8 4,000 3100 F9 = (3200 + 3600 + 4000)/3 = 3600
9 3,900 3600 F10 = (3600 + 4000 + 3900)/3 = 3833
10 4,000 3833 F11 = (4000 + 3900 + 4000)/3 =3967
11 4,200 3967 F12 =(3900 + 4000 + 4200)/3 = 4033
12 4,300 4033 F13 = (4000 + 4200 + 4300)/3 = 4167
13 4,900 4167 F14 = (4200 + 4300 + 4900) = 4467
14 5,300 4467
4.
Q1 = 60
Q2 = 70
I1 = 1000
I2 = 1200
2 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Q1 – Q2 I1 + I2
Income Elasticity of Demand E1 = x
I2 - I1 Q2 – Q1
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 1000 + 1200
E1 = x
1200 – 1000 70 + 60
22000
E1 = = 0.846
26000
5.
P1 = Rs.40
P2 = Rs.50
Q1 = 1,00,000
Q2 = 95,000
Q2 – Q1 P1 + P2
Price Elasticity of Demand = Ep = x
P2 –P1 Q2 + Q1
95000 - 100000 40 + 50
Ep = x
50 - 40 95000 + 100000
- 45
Ep = = - 0.0231
1950
3 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Chapter 6 FINANCIAL ESTIMATES AND PROJECTIONS
Sources of Funds
Profit before interest and tax 4.5
Depreciation provision for the year 1.5
Secured term loan 1.0
Total (A) 7.0
Disposition of Funds
Capital expenditure 1.50
Increase in working capital∗ 0.35
Repayment of term loan 0.50
Interest 1.20
Tax 1.80
Dividends 1.00
Total (B) 6.35
∗
Working capital here is defined as :
(Current assets other than cash) – (Current liabilities other than bank borrowings)
In this case inventories increase by 0.5 million, receivables increase by 0.2 million and current liabilities and provisions
increase by 0.35 million. So working capital increases by 0.35 million
4 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Profit before interest and tax 1166
Depreciation 319
Write off preliminary expenses 15
4800 3900
Uses
Capital expenditure 3900 -
Current assets (other than cash) - 2400
Interest - 1044
Preliminary expenses 150 -
Pre-operative expenses 600 -
4650 3444
Opening cash balance 0 150
Net surplus / deficit 150 456
Closing balance 150 606
5 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Chapter 7 THE TIME VALUE OF MONEY
1. Value five years hence of a deposit of Rs.1,000 at various interest rates is as follows:
3. In 12 years Rs.1000 grows to Rs.8000 or 8 times. This is 23 times the initial deposit.
Hence doubling takes place in 12 / 3 = 4 years.
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.
6 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
(5.000 – 4.411) x 2%
r = 16% + = 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
10. The present value of an annual pension of Rs.10,000 for 15 years when r = 15% is:
Obviously, Mr. Jingo will be better off with the annual pension amount of Rs.10,000.
7 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
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:
Rs.50,000 / PVIF (10%, 14 years) = Rs.50,000 / 3.797 = Rs.13,165
5.019 – 5.00
r = 15% + ---------------- x 3%
5.019 – 4.494
= 15.1%
= Rs.2590.9
Similarly,
PV (Stream B) = Rs.3,625.2
8 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
PV (Stream C) = Rs.2,851.1
19. A B C
20. 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
= = Rs.40,388
PVIF(12%, 8 years) 2.476
21. The interest rate implicit in the offer of Rs.20,000 after 10 years in lieu of Rs.5,000 now is:
Rs.20,000
FVIF (r,10 years) = = 4.000
Rs.5,000
9 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
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. A constant deposit at the beginning of each year represents an annuity due.
To provide a sum of Rs.50,000 at the end of 10 years the annual deposit should be
Rs.50,000
A = 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. The discounted value of the annuity of Rs.2000 receivable for 30 years, evaluated as at the
end of 9th year is:
Rs.2,000 x PVIFA (10%, 30 years) = Rs.2,000 x 9.427 = Rs.18,854
The present value of Rs.18,854 is:
Rs.18,854 x PVIF (10%, 9 years)
= Rs.18,854 x 0.424
= Rs.7,994
26. 30 percent of the pension amount is
0.30 x Rs.600 = Rs.180
Assuming that the monthly interest rate corresponding to an annual interest rate of
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
10 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
If Mr. Ramesh borrows Rs.P today on which the monthly interest rate is 1%
P x (1.01)60 = Rs.14,998
P x 1.817 = Rs.14,998
Rs.14,998
P = ------------ = Rs.8254
1.817
21.244 – 20.000
r = 1% + ---------------------- x 1%
21.244 – 18,914
= 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. The discounted value of the debentures to be redeemed between 8 to 10 years evaluated at
the end of the 5th year is:
Rs.10 million x PVIF (8%, 3 years)
+ Rs.10 million x PVIF (8%, 4 years)
+ Rs.10 million x PVIF (8%, 5 years)
= Rs.10 million (0.794 + 0.735 + 0.681)
= Rs.2.21 million
If A is the annual deposit to be made in the sinking fund for the years 1 to 5, then
A x FVIFA (8%, 5 years) = Rs.2.21 million
A x 5.867 = Rs.2.21 million
A = 5.867 = Rs.2.21 million
A = Rs.2.21 million / 5.867 = Rs.0.377 million
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
11 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
5.000 – 4.868
n=7+ ----------------- x 1 = 7.3 years
5.335 – 4.868
31. 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. Expected value of iron ore mined during year 1 = Rs.300 million
Expected present value of the iron ore that can be mined over the next 15 years assuming
a price escalation of 6% per annum in the price per ton of iron
1 – (1 + g)n / (1 + i)n
= Rs.300 million x ------------------------
i-g
12 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Chapter 8 INVESTMENT CRITERIA
100,000 200,000
= - 1,000,000 + ---------- + ------------
(1.14) (1.14)2
= - 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) Payback period = 5 years
b) NPV = 40000 x PVIFA (12%,10) – 200 000
= 26000
c) IRR (r ) can be obtained by solving the equation:
40000 x PVIFA (r, 10) = 200000
i.e., PVIFA (r, 10) = 5.000
13 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
PVIFA (16%,10) = 4.883
Linear interpolation in this range yields
r = 15 + 1 x (0.019 / 0.136)
= 15.14%
Investment B
a) Payback period = 9 years
d) BCR = PVB / I
= 194,661 / 300,000 = 0.65
Investment C
a) Payback period lies between 2 years and 3 years. Linear interpolation in
This range provides an approximate payback period of 2.88 years.
14 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
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)
Among the four alternative investments, the investment to be chosen is ‘C’ because it has
the
a. Lowest payback period
b. Highest NPV
c. Highest IRR
d. Highest BCR
3. 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 cash flow 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 cash flow, we get two values for the IRR of the
cash flow stream. In such cases, the IRR rule breaks down.
5. Define NCF as the minimum constant annual net cash flow that justifies the purchase of the
given equipment. The value of NCF can be obtained from the equation
NCF x PVIFA (10%,8) = 500000
15 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
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
9. NPV profiles for Projects P and Q for selected discount rates are as follows:
(a) Project
P Q
Discount rate (%)
0 2950 500
5 1876 208
10 1075 - 28
15 471 - 222
20 11 - 382
-1000 -1200 x PVIF (r,1) – 600 x PVIF (r,2) – 250 x PVIF (r,3)
+ 2000 x PVIF (r,4) + 4000 x PVIF (r,5) = 0
(ii) The IRR (r') of project Q can be obtained by solving the following equation for r'
-1600 + 200 x PVIF (r',1) + 400 x PVIF (r',2) + 600 x PVIF (r',3)
+ 800 x PVIF (r',4) + 100 x PVIF (r',5) = 0
16 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
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) 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%
10.
(a) Project A
NPV at a cost of capital of 12%
= - 100 + 25 x PVIFA (12%,6)
= Rs.2.79 million
Project B
NPV at a cost of capital of 12%
= - 50 + 13 x PVIFA (12%,6)
= Rs.3.45 million
17 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
IRR (r'') of the differential project can be obtained from the equation
12 x PVIFA (r'', 6) = 50
i.e., r'' = 11.53%
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 = 12% p.a
PV of cash flows up to the end of year 2 = 24.97
PV of cash flows up to the end of year 3 = 47.75
PV of cash flows up to the end of year 4 = 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 = 12% per annum
PV of cash flows up to the end of year 1 = 33.93
PV of cash flows up to the end of year 2 = 51.47
DPB lies between 1 and 2 years. Interpolating in this range we get an approximate DPB of
1.92 years.
(c) Project M
Cost of capital = 12% per annum
NPV = - 50 + 11 x PVIFA (12%,1)
+ 19 x PVIF (12%,2) + 32 x PVIF (12%,3)
+ 37 x PVIF (12%,4)
= Rs.21.26 million
Project N
Cost of capital = 12% per annum
NPV = Rs.20.63 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 = 10% per annum
NPV = Rs.25.02 million
Project N
Cost of capital = 10% per annum
NPV = Rs.23.08 million
18 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
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 = 15% per annum
NPV = 16.13 million
Project N
Cost of capital: 15% per annum
NPV = Rs.17.23 million
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 = 23.26%
19 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
13. Rs. in lakhs
Year 1 2 3 4 5 6 7 8 Sum Average
Investment 24.0 21.0 18.0 15.0 12.0 9.0 6.0 3.0 108 13.500
Depreciation 3.0 3.0 3.0 3.0 3.0 3.0 3.0 3.0 24.0 3.000
Income before 6.0 6.5 7.0 7.0 7.0 6.5 6.0 5.0 51.0 6.375
interest and tax
Interest 2.5 2.5 2.5 2.5 2.5 2.5 2.5 2.5 20.0 2.500
Income before tax 3.5 4.0 4.5 4.5 4.5 4.0 3.5 2.5 31.0 3.875
Tax - 1.0 2.5 2.5 2.5 2.2 1.9 1.4 14.0 1.750
Income after tax 3.5 3.0 2.0 2.0 2.0 1.8 1.6 1.1 17.0 2.125
20 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Chapter 9 PROJECT CASH FLOWS
1.
(a) Project Cash Flows (Rs. in million)
Year 0 1 2 3 4 5 6 7
6. Profit before tax 112.5 121.87 128.91 134.18 138.13 141.1 143.33
8. Profit after tax 78.75 85.31 90.24 93.93 96.69 98.77 100.33
14. NCF (200) 116.25 113.44 111.33 109.75 108.56 107.67 205
(c) IRR (r) of the project can be obtained by solving the following equation for r
Through a process of trial and error, we get r = 55.17%. The IRR of the project is
55.17%.
21 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
2. Post-tax Incremental Cash Flows (Rs. in million)
Year 0 1 2 3 4 5 6 7
21. Net cash flow (140) 10.20 20.55 31.46 62.80 49.25 35.94 55.00
(17+18-19+20)
(b) NPV of the net cash flow stream @ 15% per discount rate
22 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
B. Operating cash flow (years 1 through 5)
Year 1 2 3 4 5
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
D. Net cash flows associated with the replacement project (in Rs)
Year 0 1 2 3 4 5
23 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
5. A. Initial outlay (at time 0)
Year 1 2 3 4 5
i. Depreciation
of old machine 18000 14400 11520 9216 7373
ii. Depreciation
of new machine 100000 75000 56250 42188 31641
Year 0 1 2 3 4 5
24 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
assets
13. Repayment of term-loans
14. Redemption of preference capital
15. Repayment of short-term bank 100
borrowings
16. Retirement of trade creditors 50
17. Initial investment (1) (100)
18. Operating cash flows (9-10+4) 107.665 94.53 88.27 85.095 83.98 84.235
19. Liquidation and retirement cash 107.665 54.53 48.27 45.095 43.98 90
flows (11+12-13-14-15-16)
20. Net cash flows (17+18+19) (100) 107.665 54.53 48.27 45.095 43.98 174.235
25 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
1.
(a) NPV of the project = -250 + 50 x PVIFA (13%,10)
= Rs.21.31 million
Assumptions: (1) The useful life is assumed to be 10 years under all three
scenarios. It is also assumed that the salvage value of the
investment after ten years is zero.
(3) The tax rate has been calculated from the given table i.e. 10 / 35 x
100 = 28.57%.
(4) It is assumed that only loss on this project can be offset against the
taxable profit on other projects of the company; and thus the
company can claim a tax shield on the loss in the same year.
26 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
iv. Financial break even level of sales = 238.74 / 1.1628 = Rs.205.31 million
2.
(a) Sensitivity of NPV with respect to quantity manufactured and sold: (in Rs)
Pessimistic Expected Optimistic
27 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
iii. Break-even level of sales = 5000 / 0.3333 = Rs.15000
Financial break-even point
i. Annual cash flow = 0.5 x (0.3333 Sales – 5000) = 2000
ii. PV of annual cash flow = (i) x PVIFA (10%,5)
= 0.6318 sales – 1896
iii. Initial investment = 30000
iv. Break-even level of sales = 31896 / 0.6318 = Rs.50484
σ22 = 0.56
σ32 = 0.49
= 1.00
σ (NPV) = Rs.1.00 million
3. Expected NPV
4 At
= ∑ - 25,000
t=1 (1.08)t
4 σt
∑
t=1 (1.08)t
4. Expected NPV
4 At
= ∑ - 25,000 …. (1)
t
t=1 (1.06)
A1 = 2,000 x 0.2 + 3,000 x 0.5 + 4,000 x 0.3
= 3,100
29 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
σ NPV = 1,679,150 = Rs.1,296
0 – 3044
= Prob Z<
1296
The required probability is given by the shaded area in the following normal curve.
The required probability is given by the shaded area of the following normal
curve:
P(Z > - 0.81) = 0.5 + P(-0.81 < Z < 0)
= 0.5 + P(0 < Z < 0.81)
= 0.5 + 0.2910
= 0.7910
5. 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
NPV = ---------------------------------------------------------- + ------- - 30,000
(1.1)t (1.1)5
5
∑ 0.5 Q (P – V) – 500
t=1 ------------------------------------ - 30,000
(1.1)t
30 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
= [ 0.5Q (P – V) – 500] x PVIFA (10,5) – 30,000
= [0.5Q (P – V) – 500] x 3.791 – 30,000
= 1.8955Q (P – V) – 31,895.5
Exhibit 1 presents the correspondence between the values of exogenous variables and the
two digit random number. Exhibit 2 shows the results of the simulation.
Exhibit 1
Correspondence between values of exogenous variables and two digit random numbers
QUANTITY PRICE VARIABLE COST
Two Two digit Two
Cumulative digit Cumulative random Cumul digit
Value Prob Prob. random Value Prob Prob. numbers Value Prob ative random
numbers Prob. numbers
800 0.10 0.10 00 to 09 20 0.40 0.40 00 to 39 15 0.30 0.30 00 to 29
1,000 0.10 0.20 10 to 19 30 0.40 0.80 40 to 79 20 0.50 0.80 30 to 79
1,200 0.20 0.40 20 to 39 40 0.10 0.90 80 to 89 40 0.20 1.00 80 to 99
1,400 0.30 0.70 40 to 69 50 0.10 1.00 90 to 99
1,600 0.20 0.90 70 to 89
1,800 0.10 1.00 90 to 99
Exhibit 2
Simulation Results
QUANTITY (Q) PRICE (P) VARIABLE COST (V) NPV
Run Random Corres- Random Corres- Random Corres- 1.8955 Q(P-V)-31,895.5
Number ponding Number ponding Number ponding
Value value value
1 03 800 38 20 17 15 -24,314
2 32 1,200 69 30 24 15 2,224
3 61 1,400 30 20 03 15 -18,627
4 48 1,400 60 30 83 40 -58,433
5 32 1,200 19 20 11 15 -20,523
6 31 1,200 88 40 30 20 13,597
7 22 1,200 78 30 41 20 -9,150
8 46 1,400 11 20 52 20 -31,896
9 57 1,400 20 20 15 15 -18,627
QUANTITY (Q) PRICE (P) VARIABLE COST (V) NPV
Run Random Corres- Random Corres- Random Corres- 1.8955 Q(P-V)-31,895.5
Number ponding Number ponding Number ponding
Value value value
10 92 1,800 77 30 38 20 2,224
11 25 1,200 65 30 36 20 -9,150
12 64 1,400 04 20 83 40 -84,970
13 14 1,000 51 30 72 20 -12,941
14 05 800 39 20 81 40 -62,224
15 07 800 90 50 40 20 13,597
16 34 1,200 63 30 67 20 -9,150
17 79 1,600 91 50 99 40 -1,568
18 55 1,400 54 30 64 20 -5,359
19 57 1,400 12 20 19 15 -18,627
20 53 1,400 78 30 22 15 7,910
21 36 1,200 79 30 96 40 -54,642
22 32 1,200 22 20 75 20 -31,896
23 49 1,400 93 50 88 40 -5,359
24 21 1,200 84 40 35 20 13,597
25 08 .800 70 30 27 15 -9,150
26 85 1,600 63 30 69 20 -1,568
27 61 1,400 68 30 16 15 7,910
31 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
28 25 1,200 81 40 39 20 13,597
29 51 1,400 76 30 38 20 -5,359
30 32 1,200 47 30 46 20 -9,150
31 52 1,400 61 30 58 20 -5,359
32 76 1,600 18 20 41 20 -31,896
33 43 1,400 04 20 49 20 -31,896
34 70 1,600 11 20 59 20 -31,896
35 67 1,400 35 20 26 15 -18,627
36 26 1,200 63 30 22 15 2,224
QUANTITY (Q) PRICE (P) VARIABLE COST (V) NPV
Run Random Corres- Random Corres- Random Corres- 1.8955 Q(P-V)-31,895.5
Number ponding Number ponding Number ponding
Value value value
37 89 1,600 86 40 59 20 28,761
38 94 1,800 00 20 25 15 -14,836
39 09 .800 15 20 29 15 -24,314
40 44 1,400 84 40 21 15 34,447
41 98 1,800 23 20 79 20 -31,896
42 10 1,000 53 30 77 20 -12,941
43 38 1,200 44 30 31 20 -9,150
44 83 1,600 30 20 10 15 -16,732
45 54 1,400 71 30 52 20 -5,359
46 16 1,000 70 30 19 15 -3,463
47 20 1,200 65 30 87 40 -54,642
48 61 1,400 61 30 70 20 -5,359
49 82 1,600 48 30 97 40 -62,224
50 90 1,800 50 30 43 20 2,224
50
Variance of NPV = 1/50 ∑ (NPVi – NPV)2
i=1
6. 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
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 5
t=1 (1.1) (1.1)
5 5Q - 500
= ∑ - 30,000
t
t=1 (1.1)
The net present values for various values of Q are given in the following table:
5 700 P – 14,500
= ∑ - 30,000
t=1 (1.1)t
The net present values for various values of P are given below :
P (Rs) 20 30 40 50
NPV(Rs) -31,896 -5,359 21,179 47,716
8. NPV -5 0 5 10 15 20
(Rs.in lakhs)
PI 0.9 1.00 1.10 1.20 1.30 1.40
33 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
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%
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: NPV = ∑ - 10,000 = Rs.2,333
t
t=1 (1.12)
5 11,000
Project B: NPV = ∑ - 30,000 = Rs.7,763
t
t=1 (1.14)
PI 1.23 1.26
IRR 20% 24.3%
B is superior to A in terms of NPV, PI, and IRR. Hence the company must choose B.
34 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Chapter 13 SPECIAL DECISION SITUATIONS
1. PV Cost
UAE =
PVIFAr,n
= 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
Since the less costly overhaul has a lower UAE, it is the preferred alternative
35 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
36 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
4 22,000 0.636 13,992 3.037 4,607
5 15,000 0.567 8,505 3.605 2,359
37 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Calculation of UAE (SV) for Various Replacement Periods
Time Salvage PVIF Present value of PVIFA UAE of salvage
value Rs. (12%, t) salvage value Rs. (12%, t) value Rs. (4)/ (5)
(1) (2) (3) (4) (5) (6)
1 2,800,000 0.893 267,900 0.893 2,800,000
2 2,000,000 0.797 1,594,000 1.690 943,195
3 1,400,000 0.712 996,80 2.402 414,988
4 1,000,000 0.636 636,000 3.037 209,417
5 800,000 0.567 453,600 3.605 125,825
9.
a. Base case NPV = -12,000,000 + 3,000,000 x PVIFA (20%, b)
= -12,000,000 + 3,000,000 x 3,326
= - Rs.2,022,000
b. Adjusted NPV = Base case NPV – Issue cost + Present value of tax shield.
Term loan = Rs.8 million Equity finance = Rs.4 million
Issue cost of equity = 12%
Rs.4,000,000
Equity to be issued = = Rs.4,545,455
0.88
Cost of equity issue = Rs.545,455
38 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Computation of Tax Shield Associated with Debt Finance
Year (t) Debt outstanding Interest Tax shield Present value of
at the beginning tax shield
Rs. Rs. Rs. Rs.
1 8,000,000 1,440,000 432,000 366,102
2 8,000,000 1,440,000 432,000 310,256
3 7,000,000 1,260,000 378,000 230,062
4 6,000,000 1,080,000 324,000 167,116
5 5,000,000 900,000 270,000 118,019
6 4,000,000 720,000 216,000 80,013
1,271,568
10.
a. Base Case NPV = - 8,000,000 + 2,000,000 x PVIFA (18%, 6)
= - 8,000,000 + 2,000,000 x 3,498
= - Rs.1,004,000
b. Adjusted NPV = Base case NPV – Issue cost + Present value of tax shield.
Term loan = Rs.5 million
Equity finance = Rs.3 million
Issue cost of equity = 10%
Rs.3,000,000
Hence, Equity to be issued = = Rs.3,333,333
0.90
Cost of equity issue = Rs.333,333
39 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
5807.6 4633.6
+ +
(1.18)5 (1.18)6
= Rs.3406.2 million
40 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
Chapter 14 SOCIAL COST BENEFIT ANALYSIS
The IRR of the stream of social costs and benefits is the value of r in the
equation
50 40 + 3.6 – 3.0 50 40.6
400 = Σ = Σ
t=1 (1+r)t t=1 (1+r)t
Benefits
1. Resale value of the diesel train (one time) Rs.240,000
2. Avoidance of annual cash loss Rs.400,000
Fare collection = 1000 x 250 x Rs.4
= Rs.1,000,000
Cash operating expenses = Rs.1,400,000
3. The social costs and benefits of the project are estimated below: (Rs. in million)
Costs & Benefits Time Economic Explanation
value
1. Construction cost 0 24
2. Land development cost 0 150
3. Maintenance cost 1-40 1
4. Labour cost 0 40 This includes the cost of
transport and rehabilitation
5. Labour cost 1-40 12 The shadow price of labour
equals what others are willing
to pay.
6. Decrease in the value of the timber 2-40 4
41 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
output
Benefits
7. Savings in the cost of shipping the 1-40 0.5
agriculture produce
8. Income from cash crops 1-5 10
9. Income from the main crop 6-40 50
10. Increase in the value of timber output 1 20
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:
40 1 + 12 40 4
NPV = - 24 - 150 - 40 - Σ - Σ
t=1 (1.1)t t=2 (1.1)t
40 0.5 5 10 40 50 20
+ Σ + Σ + Σ +
t=1 (1.1)t t=1 (1.1)t t=6 (1.1)t (1.1)1
= - Rs.9.93 million
4. Table 1
Social Costs Associated with the Initial Outlay Rs. in million
Item Financial Basis of Tradeable value T L R
cost conversion ab initio
Land 0.30 SCF = 1/1.5 0.20
Buildings 12.0 T=0.50, L=0.25 6.0 3.0 3.0
R=0.25
Imported equipment 15.0 CIF value 9.0
Indigeneous equipment 80.0 CIF value 60.0
Transport 2.0 T=0.65, L=0.25 1.3 0.5 0.2
R=0.10
Engineering and know-how 6.0 SCF=1.5 9.0
fees
Pre-operative expenses 6.0 SCF=1.0 6.0
Bank charges 3.7 SCF=0.02 0.074
Working capital 25.0 SCF=0.8 20.0
requirement
150.0 104.274 7.3 3.5 3.2
42 By M. Iftikhar Mubbashir
Problems’ Solutions Project Evaluation
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 :
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 :
43 By M. Iftikhar Mubbashir