Advanced capital Budgeting

1 Net Present value

E9
Initial Investment 10000

Cash flows for 3years 6000 Da

costof capital 10
calculate NPV
0th 1st 2ⁿᵈ 3ʳᵈ
6000 6000 6000

D v of all cash flows 9 101

qq.ir calculator
14921 609ps
6000 1.10 mt me
mtg
6000 1.10 gt
NPV Pv of all Cash Inflows Initial Investment

14921 10000
4921

Small E9 Pratin Pankaj

case Initial Investment 100000 Case II Initial Investment 100000

cash Inflows is Istym 115000 cash Inflows is Istym 120000

required rate 15 Geocy required rate 15 Gcoc

on 1st OM 1st
115000 120000

PVC I 100000 115,9 pret longus 12098

Inteney 100000 I I 100000

NPV 0 NPV 43h8 Accepted

 Project Internal Rateof Return
It means How much metun is generated internally by Project
IRR is the mate of which NPV is zero
At IRR IVCI Puco 0M Initial Investment

At NPV 0 IRR is equivalent to cost of capital

Small E9 Pratin Pankaj

case Initial Investment 100000 Case II Initial Investment 100000

cash Inflows is Istym 115000 cash Inflows is Istym 120000

To calculate Irr to calculate IRR

0th estym 0th isty.rs

115000 120000
100000 IRR 1 100000 IRR

At 12 Dv 102678.5 At 15 PV 104348

At 14 PV 100877.2 At 194 Pv 100840.34

PV 84034 1666791
At 16 99138 2 100000
At 21 PV 99173 55
100877.2 877.2N 14
1739.214 2 9
100000
if PV balls 1666.79 Rate 2
99138 16 in 1 766679
840.34
84034 a 1
gg
If PV falls 1739.2 Rate increases 29 1.008
I 1439.2 1
87712 1 877.2
ftp.g.z
1 increase IRR 19 1 20

IRR 14 1
151
 E.g Initial Investment 500000

cashflows P.a for 3years 250000 p.a for 3years

Required rate return
of 10
calculate NPV and Internal rate of Metum

NPV 121713

At 22 NPV 510560.35
1056035 15234 58
21 500000
At 24 NPV 495325.77

if PV balk 15234.58 Rate inc

a I 1 234.58
1056035 1 39
10560.35 in a 25234.58

IRR 22 1139 24 394

Example
Suppose there are two Projects
1 Project Initial Investment 1000000 cash flows410yrs 200000p.a
A
2 Project B 1 1000000 labsflows 437ms 500000 p h

Assume cost
of capital 10

Project A

Pv of all cash inflows 200000 DVIFA 101,104ns 1228913

Initial investment 1000000

NPV 228913
 Project B
PV cash Inflows 500000 PVIFA 10 Byns 1243426
of all
1000000
Initial investment
NPV 2 243426

IRR of Project A I1 1000000 offfrom 2000007

At 15 Pv 10,03 754
1000000 IRR 15.10
PV 9,66 645.50
At 16

IRR Project B It 600000 CIF sym 5000007

of
At 231 PV 10,05687
1000000 IRR 2338
At 24 PV 9 90,652

Project using Modified Infernal Mate of return

Evaluation
of
Project B

OMyou 1st 2nd 3rd

1000000 500000 500000 500000

2338 616900
1 2338

Our required Amocof after Byms at 23381 will be

1000000 2338 2338 2338 on 1000000 1 233873

1878167 which is close to 1878037

i e required Mate is achieved
 MIRR Realistic Approach

Omyr 1st 2ⁿᵈ 3ʳᵈ

1000000 500000 500000 500000
500000
1.10 550000
500000
xp 605000
1655000

1655000 s
MIRR 1 655 1.1429
1000000
1 655Viatimes

ie 18.29 t 1
12times

cal of MIRR of Project A Home work Approx 11 12 7

Considering NPV IRR MIRR it is advised that investment in Project B

is a better choice

Eg
Initial Investment 20000
cash flows sym 9000
Cost of capital 2 10

fat NPV IRR and MIRR

NPV 2382 IRR 16.65 MIRR 14.24
 cash flows Project cashflows
calculation of Annual Exam Impose

Revenue 5000000

Cost 2000000

c Dept Non cash item 000000

EBIT OM EBT 2000000 Project cash flows

Potject CashFlows No Int Exp
11 tax 30 6000007
PAT ON NOPAT 1400000 Equity cashFlows 9nFEXP

Dep 1000000
41
2400000
cash flows of Project

Alternatively metof tax

Revenue 5000000 Revenue net 3500000
oftax
it lost 2000000
netfta7
Dept Non calm Dept tax saving 300000
1
EBIDAT 2400000
3000000
C tax EYP 600000
43000000 1000000
30
Cash flows 2400000
 Illustration 2
1ˢᵗ 2ⁿᵈ and 4ᵗʰ
Revenue 660000 839300 1035936 1108452

Cost 336000 492800 537152 5801247

Dep No Inflationeffect 200000 200000 200000 2000007

FBIT on EBT 124000 146500 298784 328328

1 1 tax 60
PAT 49600 58600 119514 131331

1 Dept 200000 200000 200000 200000

cash Flows 249600 258600 319514 331331

4.909 X 826 751 683
226909

Pv of all cash Inflows 906744

1Initial investment 800000

NPV 106744

Illustration KAI 501 is wrong

Carmeltans
0ᵗʰ 1st 24 3ʳᵈ 4ᵗʰ
Initial investment 40000

33000 36300 39930 43923

Annual Revenue
Annual cost 11000 12100 13310 14641

Idea 10000 10000

Dept No inflation Adjustment 10000

PBT 12000 14200 16620 19282

501 6000 7100 8310 9641
fry
8310 9641
PAY 6000 700
Dep 10000 foooo lover from
40000 16000
Nominal C F 17100 18310 19641
Nomi Tartrate 121
I diviofallcash inflows 412 7 53433
Prv
of cashoutblong 40000

NPV 13433

I Project should be
accepted

Alternative 501
Nominal discount rate 12 Inflation 10

i Real discount mate 1 1.0182 1.82

Dothis in Exam
Calculation
of Real cashflows
Revenue 30000 30000 30000 30000
Cost 10000 10000 10000 70000

Dept 10000 10000 10000 10000

PBT 10000 10000 10000 10000

Tax 50
PAT 5000 5000 5000 5000
Dept 10000 10000 10000 10000

Real Cash Flows 15000 15000 15000 15000

PV 1.821 14732 14469 14210 13956

3935
of
PV
of all cashInflows 57367 Differencenin Answer is due

1 Initial Investment 40000 to inflation effect in Dept

NPV 17367 tax saving
Dv ofDep forbovine 12 Dis 15187
Dv ofDep 1.82 1 19122
3935
E9 Real Discount rate 6
Inflation Premium 5
I Nominal Discount rate 1.06 1 05 11.3
Initial Investment 20000

Real cash flows 1914m 10000 2ndyn 15000 3ʳᵈyn 15000

Calculate NPV

Alternative

Real cash flows Inflation NominaCffPu 11.31 PYof CIF

1ˢᵗ 10000 1.05 10500 898 9429
2ⁿᵈ 15000 1.05 16537.5 807 13346

and 15000 105 17364.38 725 12589

Dv all cash Inflows 35364

of
Initial Investment 20000

NPV 15364

Alternatively

Npv 105,9 1951

5 17ᵗʰ 20000 15380

Alternative 2

Real cash flows PV RealDis.mateof6 P.v

1ˢᵗ 10000 993 9430
2ⁿᵈ 15000 890 13350
and 15000 840 12600

Dv of all cash inflows 35380

initial investment 2 20000

NPV 15380

I In both Alternative NPV is approximately close and same

 Techniques
of Risk Analysis in Capital Budgeting Decisions

1 Statistical techniques 2 Conventional Techniques 3 other techniques

I

Probability RiskAdjusted Dis mate sensitivity Analysis

varianceon Standard Deviation Certainty Equivalent Scenario Analysis

Coefficientof variation simulation

Decision tree

1 Statistical Analysis

E.g Cash flows for Year 1

Scenarios Cash Flow Probabilities Expected cashflows

Best 50000 25 12500

Good 40000 60 24000

Worst 30000 15 4500

ECF for yead I 41000

Cash flows
for yead 2
Scenarios Cash Flow Probabilities Expected cashflows

30 18000
Best 60000

Good 40000 40 16000

Worst 20000 30 6000

ECF for year 2 40000

Cash flows
for yead B
Scenarios Cash Flow Probabilities Expected cashflows

Best 60000 35 21000

Good 50000 45 22500

Worst 30000 20 6000

ECF for year 3 49500

 Suppose Initial Investment 80000 and Discount rate 10

whether Project should be accepted or not

Note Cash flows are independent

yeah cashflows p.vi 1oy.P.v 0th 1st 201 59

1 41000 37269 410 4000 49500
909 37273
2 40000 826 37058
33040
37190
3 49500 751 37175
PV 107484
of all elf
80000
initial Investment
NPV 27484

Calculation of Risk
years
R CIF Prob a I a IT
50000 25 9000 81000000 Independiente x.rs
40000 60 1000 1000000 u x 60

30000 15 11000 121000000 X 15

x̅ 41100 Aug variance 39000000

50000
25 40000 60 S'D 39000000
30000 x 15
2 6245
years
Average cash Flow 41000
Avg variance yrs 39000000

Standard Deviation 39000000 6245

Coefficient of variation for year 1 6245

I 41000
1523
 Year
a Prob a I ca ñT
60000 40 20000 400000000 x30

0 0
40000 40
20000 30 20000 400000000 30
x̅ 40000 fu 240000000

in 15492 Yn2 Variance 240000000

Co efficient
of variation for year 2
p
15492
40000
3873
Year
n Prob n 5 a 5
60000 35 10500 110250000 0.35
50000 45 500 250000 45
30000 20 19500 380250000 20

5 49500 Me 114750000

on 10712 413 valiance 114750000

Co efficient
of variation for year 3 b
c
10712 2164
49500
Discountrate 10
Othym 1st 2ⁿᵈ 3rd
39000000 240000000 114750000

32231405 39000000
111012
240000000
110
163923229 0000
47
111107
poun Dis 10

64773383 on istyn

Prof 100 110

260928017
variance 100 1.10
105
Proofs'D 1260928017 16153 not 12100

1
1
 Here NPV of Project is 27484
9 D of Project is 16153

i Co efficient
of variation 5D
IP
on on
SEE Exp return
at othym

16153 5877
27484

2 Conventional Techniques
A Risk Free Rate
if cash flows are risk free we should use Risk free Discount
rate to calculate Pv of future cash Flows
all
Eg Investment Amount in Risk free securities 100
Riskfree rate 5
Regd Cash flows if one you maturity 100 1.05
105

E9 cash flow in 1st yr Riskfree 105

Risk fall mate 5
RADR 12
100
i Present value of future Cfr 19

B Risk Adjusted Discount Rate

if cash blows involves risk we should use RADR to cal
PV of future cash flows
RADR a Risk free rate Compensation for disk undertaken

future cash flow in Istyn Risk 2000

Rf 5 Risk Premium 7
 i RADR 5 7 12

P.v 1786
20,92

E9
Initial Investment 100000

Rf 6 fish Premium 8

Cashflows Istyn 30000 2ⁿᵈ 40000 3rd 50000 4th50000

cal NPV if Project is risky

RADR 6 8 144
In cash flow Pvr 144 Dv
1 30000 877
2 40000 769
3 50000 675
4 50000 592
D v of all CIF 120420
I I 100000

NPV 20420

c centainity Equivalent Approach

Cash flows Eg
Certainity Certainty Eg Dv ECF
Risk Co efficient cashflow Romate 6 at Dv

30000 90 27000 943

40000 85 34000 Ago
AT
50000 80 40000 tho
50000 70 35000 792
PV of all UF 117041
Initial Inv 100000

NPV 17041
 1 Dt is understood that
a In case of Risky CIF use RADR
b cent g CIF use Risk free rate

3 Other techniques

A Sensitivity Analysis
it is a risk analysis technique that examines how changes in
single variable E.g Sales cost discount rate affects a project outcome
like NPV on IRR while keeping all other variables constant
it helps identify the most critical variable influencing a project's
success or failure
Eg
Initial Investment 1000,000 Tax is ignored
SalesPrice of 60 costPrice at 40 Project life 3yrs Dis Mate 10
Salesvolume 1ˢᵗyn 20000uts 2ndyr 30000 uts 2ⁿᵈmn 30000 uts
501
1styrs cash flow 20000ms x 60 40 400000

adyn 30000 its 60 40 600000

3ʳᵈyrs 11 30000
up x 60 40 600000

Pov less initial investment

I NPV
of all cash inflow
600000 1000000
40990 49 1111073

1310293 1000000

310293
 i Initial Investment sensitivity
investment can be increased so that NPV
It means How much of initial
becomes Zero
Here initial Investment can be increased from 1000000 to 1310293 where
NPV will be zero Lie I I can be increased
by 3102937
1 Initial investment sensitivity 310293 x 100 31.03 As
1000000 RANKG
100
Ciil Sales Price at sensitivity
Let the bP fat of 290 NPN we 1 Alternative
60
AQ
20009 30099 9
x 40 30000 1
300
20000 30000 x 401 40 1000000
1110 1.10 1 107
3930879
40 9.9
1000000 Annual Rev sensitivity
29
19 NPV
PVofallRevenue 100
J a 40 418181.82 24793.39 22539.44 1000000
319,293,9 100
7.91
1 40 65514.65 1000000

N 40 1000000
6551465
verify
a 15.26 40 20000 55.26 40 30000 55.26 40
1.10 1.10
55 26
30000 55.26 40

i bP Perunit can be decreased from E 60 11.1033

10,00 000
to E 55.26 Revised salesPlice 55.26
costprice no
contribution 15.26
i Sales Price ut sensitivity 4 4 A RANKI
100 7.9

iii CostPrice ut sensitivity cont 15.26 sales 60 Cost 60 15.26 44th

since salesprice it can be decreased maximum by 4 74
Therefore Cost price it can be increased maximum by 4 74
 1 Cost Price ut 11.85 A RANK
Sensitivity 474 100
40
iv Sales volume sensitivity

Let the sales volume of NPV D be 2M 3u and 31 respectively

9
2n 60 401 3 60 40 3 60 40 1000000
110
4 pop 1111077

how
1
1000000
110 p
36.36m 49.59m 45.08 a 1000000

of 131.03 U 1000000

I 7631.84
i Sales volume in 1styrs 2n 2 763184 15263.68
Sales volume in Istyn can be decreased by 20000 15263.68 473632

1 sales volume sensitivity 413 32 00 23 684 Ans

RANK

Rough Snot bon Examy

Sales volume in Indyn 3m 3 7631184 22895.52
i Sales volume Serlifinity 30000 22895 52 100 23.68
30000

Shortcut Donotuse this shortcut in SP ut and CPut

Dv of all cash Inflows 1310293
NPV a 310293
sales volume sensitivity
II 100 310293
1310293
100

23 681
 V1 costof capital sensitivity on Discount mate sensitivity

Here we should calculate Internal Rate of Return

Ha
20000 60 40 30000 60 407 3000060 40 1000000
Itm IMI CTM
400000 wooooo
yens
citing 1
At 151 COC P.vn
of C1 1196022
At 22 101 1 1061410 15867 1
At 2570C 1011200 I 15867

it go 1000000 15867 11200 115867 11200

At 26 COC 11 995333 70

IRR 25 70 25.70

I Cost to 25.70
of Capital can be increased from
10

1 Coe sensitivity 1 70 100 157 A RANKS

v1 Project lifetime
Since Initial Investment is E 1000000 therefore Project life should be
such that DV is recovered to the extent of E
of lashInflows
1000000

Amount to be recovered from future cash flows 4inPV 1000000

3636367
at Istyn Dv of C 1
40998

Balance to be recovered 636364

c Adyn Prope 1 46099

7 495868
 Balance to be recovered 140496

3rdye Pu of 01 6999 ie 450789

c

to be done in
i of work 3dm
11 100 31.17

i No to work in 3ʳᵈ you 365days 31.17

of days
114days

I Total No of days be done 365 365 114 844days

ofwork to
Total days in a
Project 2 365 365 365 1095days

I Projectlifetime 2you 114 days 40m 8h4days

time sensitivity 1095 844

Project life 100 22.92
1095

Another Alternative solution used by ICA

I I 10100,000 5p 60 CP 40 Dis make 10 Project life 3years
sales volume 20000
uts 30000 us and 30000 us
400000 600000
NPV 1000000 310293
1110
699
7 1.1033

1 Initial Investment sensitivity

Comment Initial Investment 10,00 000

if Initial Investment adversely change by 10 Revised II 11,001000

Revised NPV 20000 60 40 30000 60 40 30000 60 40 1100000

110 1110 111073

1310293 1100000

2 210293
 I NPV change Ans
310293 210293 100 32.239
310293 Rank
NotForExam
When NPV decreases 32.23 Initial Investment changes 10
1 12.23

11 100 in 1 102.23 1009

31.03

2 Sales Price at Sensitivity

fument Sales Price Per unit 60

if sales Price adversely change by 10 Revised 5P 60 10 547

Revised NPV 54 401 30000 54407
2000015 407
30000 1000000
11107 1.1073

82745
NPV change 310293 1 82795 x 100 126.68 Arg
310293 Rank1
NotforExam
if Mpv 126.68 S.p.lt change 10
is 11 1 t 1 11 11 1
ff
100 1 11 11 1 116.68 100 7 90

3 lostPrice ut Sensitivity
Current Cost Price no pen unit
If Cost Price Per unit adversely change by 10 Revised Cl 40 101 44
Revised NPV 20000 60 4h 30000 60 44 30000 60 441 1000000
1110 1110 1.1073

48234

310293 48234 100 84.451 Ans

change of
NPV
310293
panar fast100
11.84
4 Sales volume sensitivity

If sales volume adversely change by 10

Revised NPV 18000960 40 27000 60 407 27000 60 407 1000000
110 110 1111073

179264

NPV changeof 310293 179264 100 42.23 Any RANKS

310293

19.2 100

23681

5 Costof capital sensitivity

If cost of capital adversely change by 10 Revised COC 10 10 0110 11 7

i Revised NPV 2 20000960 40 30000 60 407 30000 60 407 1000000
1111 1 11 111173

286049

I NPVchange of 310293 286049 100 7.81 And Paners

310293
E9 Annual Revenues for 3 years E 50000 pia for Byres
Annual Cost for 3 years E 20000 Pa God 3you

Initial Investment a 50000

costof capital 10

cal sensitivity to each variables

501

P 50000 24605
79

1 Annual Revenue Sensitivity

Let the Annual Revenue be a

4 20000 1 20000 50000
1 10 11,0 111013

1 20000 4.909 826 f 7517 50000

N 20000 50000
2 486

N 20113 f 20000 40113

Annual Revenue sensitivity

50000 40113 100
1 50000

9887 100 19.78

50000

2 Annual cost sensitivity 9887 100 49.435

20000
 Alternatively

1 Annual Revenue sensitivity perenne peren perer

0th 1st 2ⁿᵈ 3ʳᵈ
NPV 24605 50000 50000 50000
50000 909
Dv ofall Revenues 8
50000 0000.75
124300

Annual Revenue can be decreased by 29605 from 124300 to 99695

i Annual Rev sensitivity NPV 100

PV ofallRevenue

24605 7100 19.79

124300

2 Annual lost sensitivity

Dv 20000 909 20000 826 20000 x 751
of all Cost
20000 2.486
49720

I Annual Cost sensitivity NPV 100 24605 100

Pvofcost 49720

49 48

3 Initial inv Sensitivity NPV 100

I I

24605 100 49.21

50000

4 Coc
491
 5 Project life
recover 50000
Tope Initial investment to
300
istyre a v of C I 4 7 27273
Balance 227 27
2ndyn P v of c I 39 7 i e 24793

1 work in 2ndyn 22727 100 91.67

24793

No 365days 91 67
of days 335days

Project lifetime a 1 years and 335 days 700days

Total days 365 3 1095 days

sensitivity 2 1095 700 100 36.07

1095

CLASS WORK BU copy

913 Hw Araetice a lot

1514M cash flow 200000 30 16.5 10100,000 1700000

E 1700000 P.a will be generated for 5 years

I Cash flow
of
Discount rate 12

1 NPV 1700000 PVIFA 12 54ns 5000000

1700000 3 605 5000000

1128500

is sales price sensitivity

net Sip per unit be a
HQ 4200000 U 16.57 1000000 3 605 5000000
2000004 3300000 1000000 5009
8
 2 200000K 1386963 4300000

U z 5686963 28.43
200000

1 Sales Price Sensitivity 30 28.43 100 5.23

30

ii Cost Price Per unit sensitivity

Since Sales Price can be decreased maximum by 1.57 30 28.43
1 Cost price can be increased may by 1.57
1 91515
1 costprice sensitivity
7 100

iii sales volume sensitivity

Let Sales volume be n
AQ Ca 30 16.5 1000000 3.605 a 5000000
2 135M 1000000 5000000
3 605

13.5m 1386963 1000000

in 1 2386963 176812 ats

13.5

i Salesvolume sensitivity 200000 176812 100 11.59

200000

Iv Expected unit of Sales 175000 30 200000 60 225000 X 10

195000 units

1 Expected NPV
9195000 10 1651 10000007 3.605 5000000

885163
Here
Break even sales where Npv 0 176812 whits

NPV in worst case 130 Prob

175000 70 16.5 10000007 3.605 5000000 88187
 MPV in Best case 10 Prob
4225000 30 16.5 1000000 X 3.605 5000000 2345188
where sales 175000units and
theme is 30 chance of Negative NPV
Foy Chance
of Positive NPV sales a 200000 225000 wits
But Acceptable level
of risk is 20
i Project should not be accepted Arg

812 Practice lot

a

all know at CRR 16 Pv C I Initial investment

i Initial Investment 57500 PVIFA 161 54ns

57500 3 274
188255

liil Let costof capital be a

cost of capital sensitivity 60 I means for increased
by 60 fam
Zeno Npv on at IRRY
Ad
a 60 16
of a
1.601 16
1 2 10 10 1 COC 10
10
NPV 57500 Prifa 10 54m 188255
57500 3.791 188255
29727 50

Practice
iii NPV 2972750
Fixed cost sensitivity 7.8416
To calculate Annual fixed Cost
 Let Annual fixed cost be a
1ˢᵗ 2ⁿᵈ 3ʳᵈ 41 5ᵗʰ
Fc a n n a n

1 Dv
ofall fixedCost 3791k a PUFA10 1544
11 3791

fixed cost sensitivity NPV 100

PVof all fixedcost

7.8411 29727.50 100

3 791M

29.72750561 2972750
I R 2972750 100000
29.7275056

i Annual fixed cost 100000

Alternatively
MPV 29727 50
I Every year fixed costcanbe increased 2972750 7841.6
by 3791

fixed cost can be increased wise 7 84161

1 100 Fixedcost 7841.6
f 100000
7 8416
100000 7.8416 107841.6
10000 7841.6 107841.6
V Sales Per unit Variable cost 200
1 PVRatio
170

i Contribution Sales variablecost 200 60 140

i Break even unit fixed Cost 100000

of sales 714.28uts
contribution at 140

Iv Estimated unitof sales fixedcost cashInflow 157500 1125 its

contribution it 140

B Scenario Analysis

Scenario Analysis is a risk analysis techniquethat evaluates how changes in

multiple variables together affect the outcome of a Project Such as NPV or
IRR Unlike Sensitivity Analysis which changes one variable at a time scenario
Analysis looks at How multiple variables changing together affectthe result
It often include scenarios such as Base worst on Best case
1 Base case Assumes most likely values bom variables

Iii Best case Assumed optimistic values Higher sales lowercosts

iii worstcase Assumes Pessimistic values lower Sales Higher cost

Example

Initial Investment 100000 Project life 5years

Variables Best most likely worst

Sales 120000 100000 80000
costs 60000 70000 90000
Discountmate 8 10 12
501

i NPV in Best case scenario

4120000 60000 PVIFA 8 54ms 100000

60000 3.993 100000

139580

fil NPV in Base case scenario

100000 700007 PVIFA 10 54Mt 100000

30000 3 791 100000

13730

iii NPV in worst case scenario

4 80000 90000 PVIFA 12 54ns 100000

10000 3.605 100000

136050

Now Suppose Probabilities assigned to Best Base and worstcase Scenarios

are 10 60 and 30 respectively Cal Expected NPV and suggest

whether Project should be accepted or not

i ENDY 139580 10 13730 60 136050 30

13958 8238 40815
18619
Since ENPV is negative therefore Project should not be accepted
Iv Simulation Monte Carlo Randon No 0 99

E9 Initial Investment 30000 Discountmate 10

Cash Flowsindifferentscenario Pa Prob Cominot

Range

I 10000 40 40 0 39 hodigits

II 12000 14 54 40 53 Indigits
8000 28 82 54 81 28digits

I 15000 05 87 82 86 5digits
13000 08 95 87 9.4 8digits
know 02 97 95 96 2digits
16000 03 1 97 99 3digits
1

Random Numbers
91,13 161,517,541,15161 9191159191.78147184

Protect life in differentScenario Prob cum.pro Range

I 54ns 50 50 0 49
I 44ms 30 80 50 79
I 64ms 10 90 80 89
74ns 04 94 90 93
I 34ms 06 1 94 99
Random Numbers
10,3 122174,818119,9111 151168144,41174105

RANDOM Nos Cashflow life Prif 1oy.PVCIPVCONP

9 20 10000 5 3791 37910 30000 7910
1.3440 10000
5 3.791 37910 30000 7910
2.6434 10000 5 3791 37910 30000 7910

5232 10000 5 3791 37910 30000 7910

 7 74 10000
4 3 170 31700 30000 1700

52 88 12000 6 4355 52260 30000 22260

45 49 12000 5 3791 45492 30000 15492

60299 8000 3 2.487 19896 30000 10104

80263 8000 4 3 170 25360 30000 4640

98250 16000 4 3.170 50720 30000 20720

59268 8000 4 3.170 25360 30000 4640

91444 13000 5 3.791 49283 30000 19283

78241 8000 5 3.791 30328 30000 328

47274 12000
4 3.170 38040 30000 8040

84405 15000 5 3791 56865 30000 26865

total 126,94 8463
Average Empv

D Decision tree Analysis combination of Decision and Events

it is used to handle investment decisions that involve a sequence of
actions and future uncertainties Unlike simple accept or rejectdecisions
this technique accounts for How current decisions influence future events
and actions
Types of situations
Ii Decisions where the manager has control and can determine the
next step
ii Events where the manager has no control and probabilities are
assigned to possible outcomes
 20eac
Theo
ENPV 201 501 0 501
50
101 success NPV zero
est

149 0cost 21ns

a fe.gg nonmental NPV they
8 tto
sep Invest NPV ZEMO

Gothrough
 Miscellaneous Points Greater P I is better
P.I PVof cashInflow
1 Profitability Index
PVof cash outflow

If PI 1 then Accept the Project But if P I 21 then Reject the Project

2 utility in Decision making

concept

Utility refers to satisfaction on value derived from a particular

Outcome Decision makers are not always concerned
solely with cash
flows they are also influenced by risk preferences and Psychological
satisfaction
for Example Losing 20000 might feel more painful than gaining
2 20000 joyful utility of losing
beels 20000
Thus
may be more negative
compared to positive utility of gaining 20000
Allustration 21 5017

Protect A Project B
cashFlows utilities Drob Exp utilities CashFlows utilities Prob Exp utilities
15000 100 10 10 1a000 60 10 6
10000 60 20 12 4000 3 15 45
15000 40 40 16 15000 40 he 16
10000
30 20 6 5000 20 25 5
5000 20 10 2 10000 30 10 3
Expected utilities to Expected utilities 17.55
Since Expected utilities
of Project B is more compared to A it should be accepted
 Replacement Decisions

1 Replacement Existing Machine

of
This involves evaluating whether it is better to continue using an old

machine or replace it with a new one the decision is based on factors

like old machine's rising maintenance costs declining efficiency and salvage
value compared to the costs and benefits of the new machine

Eg Illustration12
2
CA ofold machine today 25000
9 54ms 12500
Dep Exp p.a on old machine 2500pA

Dlp tax saving on old machine 2500 30 750pia

Oldmachine

1st 2ⁿᵈ Bond 4th 5th

Dep tax Saving 750 750 750 750 750
Examff machine
is replaced

0th 1ˢᵗ 2ⁿᵈ 3rd 4ᵗʰ 5ᵗʰ

sale oldmachine 5000
of
TaxSavingon Capital loss 2250
4112500 5000 30
7
Taxsaving avoided 17501 750 7507 7507 750

50000
cost
ofNew machine
1000
salvage value

Dep taxsaving 2940 2940 2940 2940 2940

14900
Incremental sales netottal 7000 7000 700 7000 7000
4100000 101 707

Costsaving netoftax 3500 3500 3500 3500 3500

5000 X 70
42750 12690 12690 12690 12690 13690
 12690 PVIFA 10 4yrs PVIF 10 5ᵗʰym
DV of cash Inflow 13690

12690 3.170 13690 621

48729
i Incremental Benefit Dv c I P.v.co
48729 42750
5979
sinceNPX is positive we should accept the Project
optimum Replacement cycle

it determines the ideal time to replace an asset to minimize total cost

on maximize efficiency
Al machine ages its efficiency decreases leading to Higher fuel energy
and maintenance costs Additionally its salvage value diminishes over time

E9
Illustration

cost
of taxi 400000 useful life 3years cost
of capital 10

Oneyear Replacement cycle

0ᵗʰ Istyn
Cost 400000 180000

Resalevalue 280000
100000
90900
pooooox.ro

Pv oftotalcost 309100

EAC 309100 309100 hoogh p.a

lyapura 909

Two years Replacement cycle

oh 1st 2ⁿᵈ
Cost 400000 180000 210000 315331 31533

Resalevalue 230000
5471001 _826
1180000 20000
163620

165201 c 20000 x 826

PV totalcost
of 547100

Equivalent Annual Cost 547100 547100 315331 par

24ms pulfa
909 826 1.735 leastcost
 three year Replacement cycle
0th 1st 2ⁿᵈ 3ʳᵈ
Cost 400000 180000 210000 238000

Resalevalue 11680007

163620 86 70000
173460
751
52570 C

PVof totalcost 789650

EAC 789650 789650 317639

2.486
147 2117

Since EAC is least in 2 yr Replacement cycle therefore optimum Replacement

cycle is 24ms

E.g Project A
Pv of total lost 300000 likeGyms
Project B
Pvof total cost 330000
life 54ns
Discount rate 10
501 Since like is different Therefore EAC method is suitable

EAC for Project7 300000 300000 94637 Pia

hyrepulfa 3 170

EAC for Project B 330000 330000 87048 P.a

54mPuppy 3791 this is Better
824
Machine A like 34ms
on 1st 2tᵈyn grellyn

Initial cost 150000

40000 40000 40000
Maint cost Pa
994804 10 2.487
Total Cost 249480 414m57

1 Equivalent Annual cost D a 249480 249480 100314 P.a

34nsPVIFA 2487 Yeastcost

machine B life 24ns

on 1ˢᵗ 2ⁿᵈ
Initialcost 100000

Maint Cost
60000 60W
104100 4 10 1 735

Tom cost 204100 424ns

1 Equivalent Annual cost D a 209100 117637 Pa

20,419
2475PVIFA

Since EAC is least in machine A machine A is accepted

Alternatively
Machine A

calculation of PV of total cost

Initial cost 150000
PV of operating cost 4400000 PVIFA 10 3yrisY 99480
Total PV
EDU 24948 1
249480 100314
2.487
 Machine B
Calculation of PV of total cost

Initial Cost 100000

PV of operating cost460000 PVIFA 101,24ns 104100

Total PV 204100

EAC 204100 117637 p.a

1 735

927 Trouble face 501

Oneyear replacement cycle
0M Istym

Purchase Price 55000

Maintenance cost 33000

Resale value 35000

55000 20007
18187C 909

Total cost of PV.in sym 53182

EAC 59182 53182 58506 P.a
one 909
yea

Two year Replacement cycle

0ᵗʰ 1st 2ⁿᵈyn
Purchase Price 55000

Moint Cost 33000 38000

Salvagevalue 21000
55000 33000 17000
29997 909
826
14042
total Cost ofP.V.in 24ns 99039
 EAC 99039 57083 P a Gleast
1.735

ThreeYear Replacement cycle

0ᵗʰ 1ˢᵗ 2ⁿᵈ 3ʳᵈ

Purchase Price 55000

Maintbost 33000 38000 46000

Salvage 9000
55000 37000 38000 77000
29997 909
826
31388
751
27787
Total Cost atPu in 349 144172

VAC 144172 57793 P.a

2.486

Since EAC is least in two year Replacement cycle Therefore

24m replacement cycle is best

827 Alternatively
One
year replacement
Initial Cost 55000

Dv of mainf Cost 33000 x 909 29997

Resale value 35000 909 31815

P.v of total cost 53182

I EAC 53182 58506

909
 Two year Rep cycle
Initial cost 55000
38000 X 826 61385
Dv of maint cost 33000 909

Resale value 210000.820 17346

99039

I EAC 9 57083

three year Rep cycle

Initial cost 55000

38000 X 826 46000 x757 95931
Dv of maint cost 33000 909

Resale value 9000 x 751 2 6759

144172

I EAC 144172 57993

2 486

923 Replacement of Existing machine

1 Existing machine 7 Initial investment 0

2 Upgraded Machine 11 1 10,00 000

Dept 1000100 200000 pic

Salvage

50000
50008 60
3 Replaced machine 2000000 20,20000

2050000 410000p.cn
Dep
5
 option I
Existing machine upgraded machineGinitialInv 10000007
CashInflow lashInblowGPAT Dep created lshp.ir
GPATFD.fi
491 500000 550000 200000 750000 250000 870

Year 540000 590000 200000 790000 250000 756

years 580000 610000 200000 810000 230000 658

620000 650000 200000 850000 230000 572

yeah
years 660000 700000 200000 900000 240000 497
Dv of Incremental C I 808680

1 1 IncrementalCostofupgradation 1000000
Incremental NPV 191320

Existing machine Replacementwithnew machine 420120,0003

Incremental
CashInflow LPAT Dlp cashinflow PAT Dep com flow
YAMI 500000 600000 410000 1010,000 510000 X 870

4692 540000
Ghodo 410000 1050,000 510000 756
4193 580000 410000 520000 658
690000 11,00 on
Yeah 620000 530000
thoooo 410000 11150,00 572
yeary 660000 550000
800000 410000 12110,00 1497
Pv of Incremental C'I 1747930
2020000
c 1 Incremental costofRepair
Incremental NPV 272070

AS the NPV in both the new proposal is negative therefore we should

continue with the old existing machine
Q 26 Row

One Replacement
year
Purchase Price 60000

P.v of maintenance and repair 16000 X 8696 13913.6

Pv of Scrap 32000 8696 2 27827 2

46086.4
4608614
EAC 8696 52997

Two year Replacement

Purchase Price 60000

f v of maintenance and repair 416000 8696 22000 x 75617 30547.8

Pv of Scrap 24000 7561 18146 4
72401.4
EAC 72401 4 72401 4 44536
8696 7561 1 6257

Three year Replacement cycle

Purchase Price 60000

f v of maintenance and repair 48957.8

416000 8696 22000 x 7561 28000 6575

Pv of Scrap 416000 65757 10520

98437.8
EAC 98437.8 43114
2.2832

4 year Replacement Cycle

Purchase Price 60000
P.o of maintenance and repair 69542.6
416000 8696 22000 X 7561 28000 X 6575 36000 X 57187
PV of salvage value 8000 x 57187 4574 8
 124968
EAC 124968 43772
2.855

since EAC is least in three year replacement therefore optimum

replacement cycle is three years

cannotbe applied
Hillier model millionmodel

1 when cash flows are dependent but not perfectly dependent

Eg
Initial Investment 270000 Discount rate 10 Projectlife 24ms

Cash Flows estyn 2ⁿdym PATHC JointProbability

140000 I 40 40 16
160000Prob 407 150000 II 40 35 14

Here 2ndym C F
160000 III 40 X 25 10

ame dependent 180000 I 25 40 10

180000 Mob 25 1.35
on Istyn off 190000 I 25 35 0875
butnotPerfectly 200000 VI 25 25 0625
dependent
220000 VII 35 40 14
200000 Prob 357 1.32 250000 VIII 35 35 1225
270000 I 35 25 0875
L

PATHS NPV NPV JP ENPY

I 4960000 x 909 140000 x 826 270000 8920 16
I 4160000 x 909 150000 X 826 270000 660 114

III 4160000 909 160000 8267 270000 7600 10

I 4180000 x 909 180000 X 8267 270000 42300 10

4180000 x 909 190000 X
8267 270000 50560 0875

VI 4180000 x 909 200000X 826 270000 58820 10625

VII 4200000 x 909 220000 8267 270000 93520 11h

V11 4200000 x 909 250000 826 270000 118300 1225

I 4200000 x 909 270000 x 8267 270000 134820 0875

ENPY

Now using multiple Npv's we can calculate risk i e variance and S D

NPV 1106 a 5 Ca x̅
8920 16 Prob

660 14 Prob

7600 10

42300 10

50560 0875

58820 0625

93520 114

118300 1225

134820 0875
I 50951.95 variance 2570560380

SD 2570560380 50700.69

Since NPV's one at Present value therefore variance and SD calculated here
will also be at Present value

f v of variance 2570560380
11 SD 50700 69
Co efficient
of variation SD 50700.61 995
Npy 5095195
 2 when cash flows are Independent Hillier model can be applied

E.g Initial Investment 120000 Discount rate 10

Cash Flows Istym 2ⁿᵈe PATHS 51
70000 I 28
730 II
7500040706 40 100000 12
Here2ⁿᵈyrscashflows to 70000 III 21
are totally independent 95000Mob 307 30 100000 I 09
from Istyn CIF I 21
70000
130
12000041706 307 100000 VI 09

A PATH BASIC
PATH NPV NPV JP ENDV
I 75000 909 70000 826 120000 5995 28 1678.5
II 475000 909 100000 826 120000 30775 112 3693

III 495000 909 70000 826 120000 24175 21

IV 95000 909 100000 826 120000 48955 09
I 4120000 909 70000 8267 120000 46900 21

I 120000 909 100000 826 120000 71680 09

ENPV 31154 5

Npual Prob a ñ n ñ
5995 28
30775 12

24175 21
48955 09

46900 21
71680 09

5 31154.5 Variance 415876241.24

SD 20393
B Hillier model Basil
1St4M

Cashflows a Prob a ñ a 55
75000 40 19500 380250000 x 40
95000 30 500 250000 30

120000 30 25500 650250000 30

x̅ 94500 Istyn variance 347250000
Lefestyn 18634 65
stym GD

2ⁿᵈyrs shortant
Cashflows a Prob a 5 a 55 adn
70000 28 9000 81000000 28 cashraful a5 4 51
100000 12 21000 441000000 12 70000 70 9000 81000000

70000 21 9000 81000000 x 21 100000.30 4000 441 6 0

100000 of 21000 4410000004.09 7 79000 61 189000000

70000 21 9000 81000000 7.21 64

1374772
100000 09 21000 441000000 09

I 79000 2Myn variance 189000000

ECF 2dm 13747 73
2ⁿᵈym 5D

NPY 94500 909 79000 x 826 120000 31154 50

Proofvariance Istyn variance 2dym variance

4111107 441 1077 Note
JabGhivariance no
347250000 189000000
pumepullbarole
1110 1 19
tab extra square
laganar
416073014.14
 Pv of S.D 416073014.14 20397.8

3 When cash flows are Perfectly dependent Hillier model canbe applied
Eg Initial Investment 14000 Discount rate 10

CashFlows

Ohyn Istyn 2ⁿᵈyou 3dam lithyn PATI JP

8500 8500 8500 I 60 1 1 1 60

60 8500
Itf
30 5500 1 1 5500
5500 1 5500 II 40 1 1 1 40

of PATH BASIS without Applying Hilliermodel

PATH MPV MPV JP ENPU
I 8500 101 8500 0.826 8500 0.751 8500 6837 14000 12936.5 60
II 5800 1909 5520 826 5500 737 5500 6837 14000 3429.5 40

NPV al n r ca ñJ
12936.5

3429 5

x̅ 9133.7 variance

bD 4657.46

B Hillier model
istym cashflows a
prob n 5 un
8500 60 1200 1440000 X 60
5500 40 1800 3240000 40
7300 variance 2160000
1stym SD 1469.69
 I 2ⁿᵈyn 3rdyn and hthyr S'D will also 1469.69

1469 09
p.ve
of 5 D 1469.69 146969
14
1110
aug 1 10

1469 69 3 169 or 1469.69 3.170

4657 45

NPV 7300 3.169 14000 9133.7

Points to Note

1 Incaseof Partially Dependent CF Only PATH BASIS No Hillier model

2 In case of Independent C F 7 Apply Hillier model 10mPathBasis

varianceIstyn Valiance2dam

a my I mgh

3 in case
of Perfectly Dependent off 9 ApplyMillier model or PathBasis
bD Istym S'D Udyn
ITM ITM

97
I ECF 100000 30 110000 x 50 120000 20 109000

Exp Salvage 20000 30 50000 X 50 60000 20 43000

ENPV 4109000 PVIFATO 54M 43000 PVIF410 5hpm 400000

109000 3 791 43000 621 400000 39922

Iii BestcaseMPV 120000 3791 60000 x 621 400000

92180
WorstCaseMpr 100000 1 791 20000 X 621 400000 8480
110000 3.791 50000 X 621 400000 48060
Base caseNpv
 iv
Npufn Prob a I a ñJ
Rest 92180 20 52258 2730898564 20

Base 48660 8138 66227044 50

50
Worst 8480 30 48402 2342753604 730

39922 Variance 1282119316

ENI
SD 35806 69

co efficient of variation 35806.69 90

39922

95 to 1
V1 Co efficient
of variation of average project manger from
However Co efficient
ofvariation of NewProjectofMs x is 90
1 it is less risky
i Revised cost of capital 10 1 94
1 Revised ENPV
4109000 PVIFA19 54M 43000 PVIF49 5hpm 400000

109000 3.890 43000 x 650 400000 51960

Since NPV is Positive therefore Project should be accepted

Iii Probability
ofworst case if cashflows Perfectly dependent
30 1 1 XIX
30

if cash flows are independent

Probability
ofworstcase
30 X 30 X 30 X 30 30
00243
9.20
Of Istyn 2nd PATH JointProb
24000 I 08
50000 30 32000 I 123.40
140
50
Tailialoutlay 80000 44000 II 20

60 I
no 40000 2h
50
60000 50000 I 30 60
10
VI 06
60000
1

PATH Expected NPV NPV JP ENPU a JP

1 450000 909 24000 8267 80000 14726 08 1178.08
2 450000 909 32000 8267 80000 8118 12 974.16
3 450000 909 44000 8267 80000 1794 20 758.8
4 460000 909 40000 826 80000 7580 th 1819 2
5 460000 909 50000 826 80000 15840 30 4752
6 460000 909 60000 826 80000 24100 06 1446
ENPV 622376

II NPV if worstoutcome is realised NPV Prob of worstoutcome

50000 X 909 24000 X 826 80000 14726 40 20 of

i Prob
ofworstoutcome is 8 and loss 1178 4 14726 X 087

iii NPV if bestoutcome is mediced NPV Prob

ofBestoutcome
60000
X 909 60000 826 80000 24100 60 10 06

I Prob of Restoutcome is 6 and Parfit 1446 24100 6 7

it since Expected NPV is positive i e 622376 therefore Project should be accepted

RADR concept
RADR Risk free date compensation for disk undertaken

ON

RADR Risk free rate Risk premium Risk Index

E9
B16 Industry Rish Premium Re Rf 15 10 5

is cap of RADR
Project I RADR 10 1.87
5 191
Project I RADR 10 45 17 15
Project IT RADR 10 45X 6 13

Iii NPV of Projects

project I 1 ENPY 600000 PVIFA 19 hym 1500000

4600000 2.6397 1500000 83400

Project II 7 ENPV 1600000 x 870 400000 X 756 500000 x 658 200000 572 1100000

167800

Project III ENPY 4400000 x 885 600000 x

783 800000 693 1200000 x 6137 1900000

213800

Since Project III has higher NPV therefore it should be accepted

 91 other D from Past
Examoriented solar Plant A Part B
cost
ofPlant incl insttGothyn 2400000 4000000

PV ofSalvage
Play A 4400000 14867 594401
PlantBY 9400000 2394 95760

i Netcost of Plant 2340560

EACofpcantP.ae 390424 1 2340560 X 1175

275016 pra
3904240 1315

513408p a
wages Pa 100000 p.a 140000p.a

41 And material D a 480000 pra 600000 P.a

Repairs Rra 80000 pic 100000Pa

Power cost D a 2800001 a
41 240000 pro
Fixedcost P.a 60000 prL savoop.ae

1 Total Eg Annual costpra 1235016 Pia 1713408 Pa

60000000 up
No
of us Prod D
a 30000000ms

Panta 200ms 60 2500

Playis9 hounts 60 2500

I Perunit cost 1235016 1713408

60000000
3000000

041167 028557

since cost per unit

of Part B is lower as compared with Part A
Therefore Pient B proposal is advisable
 RM Practice a
lot

Augcostforboth Pride Comm

pernon 701 30 301 80
1 1 14

25km 10000 20 x 25mF 5 30 2 704

8000 20 25km
11257783

Savings in cost oftime delayed in traffic

Average Cost Per hour 30 X70 80 30 45per hour i e 4560permin

410000 1.3min 4560 365days 1779375

Highway 50
Highway y 8000 X50 1.2min 4560 365days
g 1314000

3093375
Savings in cost of startand stop

Average cost of startand stop Per vehicle 70 x 80 30 1.20 0.92

410000 50 X 0.92 x 365days 1679000

Highway
Highway y 48000 50 0.92 365days 1343200
3022200
 Savings in Cost
of Accident settlements P.a
8 14 500000 60 15000 1225000

Incremental Cost
Average Cost Perkm 2 70 5 30 2.9 Per km

Highway 10000 20 X 25km 2.9 365days 529250

Highway 8000 20 X 25km 2.9 365days 423400

952650

Netbenefitto users 3993375 3022200 1225000 9526507 6387925P.a

Iii Annual cost to state

3
Investment cost P.a 27 3 on 30000000 0888 2664000
70000
Extra maintenance cost Da
11 Savings traffic light op lost 80000
of
1 Policemen cost 150 3 3657 1642507
Savings
of
1 Annual cost to state 2489750 Pia

iii therefit cost ratio Benefit 6387925 2 5657

Cost 2489750
 Nohole Dep
of because
Koled

BSheet
Eg.sncapital 50M Bank 200cm
loan 15f 7 150cm

1 Project IRR
901 Total Project Cost 200cm
at Present

Annual Revenue 50 cm P.a

MaintEpp 45 7200 10 on Pa
Annual Cash Inflow for Project 40cm P.a

Othyre 1st 2ⁿᵈ 2ⁿᵈ 4ᵗʰ 15ᵗʰyn

lost Looen

AnnualCashInflow hoon hoon hoon hoon hoon

i Project IRR is the IRR i e mate of which Piv of all 40cmfor 154ns will
be equivalent to 200cm

it hoom PVIFA IRR 154ms 200 cm

At 18 Soon PVIFA 18 154ms 20366

At 19 hoon PVIFA 19 15yd 195.03

7
 181 203.66 8.63 14
8.63
it 200 1 8.63 9

191 195.03 3 66 f 63 3.66

424

I Project IRR 18 42 18.42

Ii Equity IRR
Equity Investment 50cm

Loan taken from F 1 151 150 Cm

I Equivalent Annual installment 150cm 65p.a

PVIFA fyy725
15y.fom15yresis1

Project Cash Inflow hour

1 1 Eg Annual Insttfor loan 25.68cm

Equity Cash Inflow 1435am Pa

Othyre 1st 2ⁿᵈ 2ⁿᵈ 15ᵗʰyn

Equity cost 50M
AnnualCashInflow 14.359 14359 14359 1435cm

I Equity IRR 14.35M DVIFA IRR 154ms 50cm

Do it yourself
i Equity IRR 289
 Project IRR on overall inv of 200 CM 18.42
Put Return paid to F 1 151
Difference 3 42

i Entire Difference of 342 37 i e 10.26 is paid to Eq

holder
I Equity CRR 18.424 10.26 28.68 28 Approx

Understanding

Difference in Project IRR and Evity IRR

50cmFI 50cm Fit 50cmfit socreswin

18.42 1842 1842 18.42

Project IRR 18421
15 151 15 281
c Int Paid to Fit
3 42 3 421 3 42 101