Traditional Methods - Problem Areas - 1

Period
1
2
3
Average Profit
Inevstment
ARR

Project A
Book Profit
NCF
3,000
6,000
2,000
5,000
1,000
4,000
2,000

Project Cost
Payback

Project C
Book Profit
1,000
2,000
3,000
2,000

9,000

9,000

9,000

22.22%

22.22%

22.22%

Traditional Methods - Problem Areas - 2

Period
1
2
3

Project B
Book Profit
NCF
2,000
5,000
2,000
5,000
2,000
5,000
2,000

Project A
NCF
5,000
5,000

Project B
NCF
5,000
5,000
5,000

10,000
2

10,000
2

NCF
4,000
5,000
6,000

Detailed Computation of Payback

1
10,000

Capital Cost
Inflows
Outflows
Net Cash Flows
Cumm. Cash Flow

2,000
3,000
-1,000
-1,000

3,000
3,000
0
-1,000

4,000
3,500
500
-500

5,000
3,500
1,500
1,000

7,000
3,500
3,500
4,500

9,000
4,000
5,000
9,500

9,000
4,500
4,500
14,000

9,000
4,500
4,500
18,500

3
5,000
0
0

Payback
2.20
1.83
1.40

NPV @
10.0%
2,386
-53
45

Pay back Tradnl

3.6364

Payback Revised

6.11

Traditional Methods - Problem Areas - 3

Discount Rate :

10%
Period

Project
A
B
C

0
-2,000
-2,000
-2,000

1
500
500
1,800

2
500
1,800
500

10

9,000
4,500
4,500
23,000

9,000
4,500
4,500
27,500

Total
10,000

2750

DCF - An Example
Year
0
1
2
3
4
5

NCF
-18,000
5,700
5,700
5,700
5,700
5,700

Est. Cost of Capital

1. NPV :
2. IRR :

2,547.22
17.57%

12.00%

Lessee
Interest Rate
No.of Periods
Loan amount
Type

10%
7
Rs. 148,000.00
1

(Asset Value)
Payments at period beginning

Installment
Rs. -27,636.38
Tax
40.00%
After Tax interest Rate
6.00%
Loan Installment & Interest Computation
Period
0
1
2
3
4
5
6

Outstanding
Rs. 148,000.00
Rs. 120,363.62
Rs. 104,763.61
Rs. 87,603.59
Rs. 68,727.58
Rs. 47,963.96
Rs. 25,123.98

Principal
Payment
Rs. -27,636.38
Rs. -15,600.01
Rs. -17,160.02
Rs. -18,876.02
Rs. -20,763.62
Rs. -22,839.98
Rs. -25,123.98

Interest
Balance
Rs. 120,363.62
Rs. 104,763.61 Rs. -12,036.36
Rs. 87,603.59 Rs. -10,476.36
Rs. 68,727.58
Rs. -8,760.36
Rs. 47,963.96
Rs. -6,872.76
Rs. 25,123.98
Rs. -4,796.40
Rs. 0.00
Rs. -2,512.40

Before Tax Analysis

End of Year
0
1
2
3
4
5
6

Installment
27,636
27,636
27,636
27,636
27,636
27,636
27,636
PV @ 10% :

148,000

After Tax Analysis

End of Year

Payment

Interest

Tax Shield

Net

0
1
2
3
4
5
6

Rs. 27,636.38
Rs. 27,636.38
Rs. 27,636.38
Rs. 27,636.38
Rs. 27,636.38
Rs. 27,636.38
Rs. 27,636.38

Rs. 12,036.36
Rs. 10,476.36
Rs. 8,760.36
Rs. 6,872.76
Rs. 4,796.40
Rs. 2,512.40

Rs. 4,814.54
Rs. 4,190.54
Rs. 3,504.14
Rs. 2,749.10
Rs. 1,918.56
Rs. 1,004.96

27,636
22,822
23,446
24,132
24,887
25,718
26,631

PV @ 6%

148,000

Total
Payment
Rs. -27,636.38
Rs. -27,636.38
Rs. -27,636.38
Rs. -27,636.38
Rs. -27,636.38
Rs. -27,636.38
Rs. -27,636.38

NPV Vs IRR
Year
0
1
2
3
Discount Rate
NPV
IRR
MIRR
Discount Rate
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
11%
12%
13%
14%
15%
16%
17%
18%
19%
20%

NCF-A
-155.22
0.00
0.00
221.00
10.00%
10.82
12.50%
12.50%
NPV -A
65.78
59.28
53.03
47.03
41.25
35.69
30.34
25.18
20.22
15.43
10.82
6.37
2.08
-2.06
-6.05
-9.91
-13.63
-17.23
-20.71
-24.08
-27.33

NCF-B NCF (A-B)

-155.22
0.00
100.00
-100.00
0.00
0.00
100.00
121.00

10.82
14.00%
12.50%

0.00
10.00%
6.56%

NPV -B NPV (A-B)

44.78
21.00
40.85
18.43
37.05
15.98
33.38
13.64
29.83
11.41
26.40
9.29
23.08
7.25
19.87
5.31
16.76
3.46
13.74
1.69
10.82
-0.00
7.99
-1.62
5.24
-3.16
2.58
-4.64
-0.00
-6.05
-2.51
-7.40
-4.95
-8.69
-7.31
-9.92
-9.61
-11.10
-11.84
-12.23
-14.02
-13.31

NPV & IRR - Conflicting Signals

80.00

60.00

NPV

40.00

20.00

0.00
0%

2%

4%

6%

8%

10%

12%

14%

-20.00

Cross-over
point
-40.00
Project A

Rate
Project B

Project (A-B)

16%

18%

20%

Multiple IRR
Lorrie & Savage Problem

Multiple IRR - 3 Roots

Year
0
1
2

Cash Flow
-1600
10000
-10000

Year
0
1
2
3

0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
55%
60%
65%
70%
75%
80%
85%
90%
95%
100%
105%
110%
115%
120%
125%
130%
135%
140%
145%
150%
155%
160%
165%
170%
175%
180%
185%
190%
195%
200%

-1,600.00
-1,146.49
-773.55
-465.78
-211.11
0.00
175.15
320.44
440.82
540.31
622.22
689.28
743.75
787.51
822.15
848.98
869.14
883.56
893.07
898.36
900.00
898.51
894.33
887.83
879.34
869.14
857.47
844.55
830.56
815.66
800.00
783.70
766.86
749.59
731.96
714.05
695.92
677.62
659.22
640.74
622.22

0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
150%
160%
170%
180%
190%
200%
210%
220%
230%
240%
250%

Cash Flow
-1000
6000
-11000
6000

0.00
-128.47
-166.67
-162.49
-139.94
-111.11
-82.03
-55.57
-32.92
-14.43
0.00
10.69
18.03
22.44
24.31
24.00
21.85
18.14
13.12
7.01
0.00
-7.75
-16.11
-24.96
-34.19
-43.73

Magnitude of Cash Flows and IRR

Year
0
1
2
3
4
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
110%
120%
130%
140%
150%
160%
170%
180%
190%
200%
210%
220%
230%
240%
250%

Cash Flow
-1000
1400
-100
100
-100
300.00
196.91
106.87
28.26
-40.61
-101.23
-154.91
-202.69
-245.47
-283.95
-318.75
-350.35
-379.17
-405.56
-429.81
-452.16
-472.83
-492.00
-509.83
-526.45
-541.98
-556.52
-570.17
-583.00
-595.09
-606.50

205%
210%
215%
220%
225%
230%
235%
240%
245%
250%
255%
260%
265%
270%
275%
280%
285%
290%
295%
300%
305%
310%
315%
320%
325%
330%
335%
340%
345%
350%
355%
360%
365%
370%
375%
380%
385%
390%
395%
400%
405%
410%
415%
420%
425%
430%
435%
440%
445%
450%
455%
460%

603.71
585.22
566.79
548.44
530.18
512.03
494.01
476.12
458.39
440.82
423.41
406.17
389.12
372.24
355.56
339.06
322.75
306.64
290.72
275.00
259.47
244.14
229.00
214.06
199.31
184.75
170.38
156.20
142.20
128.40
114.77
101.32
88.06
74.97
62.05
49.31
36.73
24.32
12.08
0.00
-11.92
-23.68
-35.29
-46.75
-58.05
-69.21
-80.22
-91.08
-101.81
-112.40
-122.85
-133.16

465%
470%
475%
480%
485%
490%
495%
500%

-143.35
-153.40
-163.33
-173.13
-182.80
-192.36
-201.79
-211.11

Flows and IRR

Lorrie & Savage Problem

1,500.00

1,000.00

500.00

0.00
100%

200%

300%

NPV

0%

-500.00

-1,000.00

-1,500.00

-2,000.00
Discount Rate

400%

500%

600%

Multiple IRR
50.00

0.00
0%

50%

100%

150%

NPV

-50.00

-100.00

-150.00

-200.00
Discount Rate

200%

250%

300%

Impact of Cash Flow Magnitude on IRR (Cash Flow with multiple change of sign)
400.00
300.00
200.00

100.00
0.00
0%

50%

100%

150%

NPV

-100.00

-200.00
-300.00
-400.00
-500.00
-600.00
-700.00
Discount Rate

200%

250%

300%

Using Future Values

Cost of capital

Initial Investment:

12.50%
300

year

FV

1
2
3
4
5

337.50
379.69
427.15
480.54
540.61

Cash inflow
year

Amt

PV

Cum.PV

FV

1
2
3
4
5

100
100
100
100
100

88.89
79.01
70.23
62.43
55.49

88.89
167.90
238.13
300.56
356.06

100.00
212.50
339.06
481.45
641.63

Discounted Pay Back

700.00
600.00
500.00

FV

400.00
FV of Investment

300.00

FV of Cash inflows
200.00
100.00
0.00
0

Year

Using Present Values

Discounted Payback

Year
1
2
3
4
5

PV Factor * Cash Outflow

0.87719
10,000
0.76947
8,000
0.67497
24,000
0.59208
15,000
0.51937
12,000

PV of Cash
Cumm. PV of
Outflows Cash Outflows
8,772
8,772
6,156
14,928
16,199
31,127
8,881
40,008
6,232
46,241

Year
1
2
3
4
5

PV Factor *
0.87719
0.76947
0.67497
0.59208
0.51937

PV of Cash
Inflows
0
12,311
24,299
23,091
12,465

* Discount Rate :

Cash Inflow
0
16,000
36,000
39,000
24,000
14%

BET = 3.42

Cumm. PV of
Cash Inflows
0
12,311
36,610
59,702
72,166

Year
0
1
2
3
4
5
Present Value
Years :
Inerest rate :

Initial Outlay/
Optg Cost
(Rs.)
1,000,000
200,000
250,000
300,000
350,000
400,000

554,304
554,304
554,304
554,304
554,304

2,101,247

2,101,247

Annuities with Rs.1 PV

Year 1
Year 2
0.26380 0.26380

1 /( 1
r -

Discount Rate :
Maturity (years) :
NPV

5
10.00%

Capital Recovery Factor (assuming 5 years life and

discount rate : 10.00 %) :- CRF =
0.2638
Equivalent Annual Cost = 2,101,247 * 0.2638 =
Assuming volume of production at :
10,000
Revenue per unit of production should be at least:

1
)
r (1 r )n

554,304
units per year
55.43

s with Rs.1 PV
Year 3
0.26380
0.2638
10%
5
1.00

Year 4
0.26380

Year 5
0.26380

Discount Rate

6%

Period
Machine
A
B

0
15.00
10.00

1
5.00
6.00

2
5.00
6.00

3
5.00

NPV
28.37
21.00

EAC
10.61
11.45

1
5.00
6.00

2
5.00
16.00

3
20.00
6.00

4
5.00
16.00

5
5.00
6.00

Alternative Approach
(Match time periods)
Machine
A
B

0
15.00
10.00

6
5.00
6.00

NPV
52.18
56.32

EAC
10.61
11.45

Capital Rationing
Budget Outlay :
Project
A
B
C
D
Combinations
A
BC
BD

300.00
Outlay
200.00
125.00
175.00
150.00

PV
430.00
266.25
369.25
312.00

NPV
230.00
141.25
194.25
162.00

PI
2.15
2.13
2.11
2.08

Outlay
200.00
300.00
275.00

PV
430.00
635.50
369.25

NPV
230.00
335.50
303.25

PI
2.15
2.12
1.34

WAPI
1.43
2.12
1.23

The following are relevant details of capital projects awaiting approval

Capital Budget Outlay :

400.00

Project
A
B
C
D

Capital
Expenditure
200.00
125.00
175.00
150.00

NPV
230.00
141.25
194.25
162.00

a Assuming each project is independent , which projects would you choose?

b Assuming that Projects B and D are mutually exclusive , which projects would you choose?
Solution
Project
A
B
C
D

Outlay
200.00
125.00
175.00
150.00

PV
430.00
266.25
369.25
312.00

NPV
230.00
141.25
194.25
162.00

Outlay
200.00
325.00

PV
430.00
696.25

WAPI1
1.08
1.74

AC

375.00

799.25

2.00

AD
B
BC
BD
C
CD
D

350.00
125.00
300.00
275.00
175.00
325.00
150.00

742.00
266.25
635.50
578.25
369.25
681.25
312.00

1.86
0.67
1.59
1.45
0.92
1.70
0.78

Combinations
A
AB

PI
2.15
2.13
2.11
2.08

2.15
2.14
2.13
2.12
2.13
2.12
2.10
2.11
2.10
2.08

weighted average profitability index- where the denominator is the budget outlay

a AC
b AC

Modified Internal Rate of Return (MIRR)

Reinvestment Rate :
Year
0
1
2
3
4
5

Cash Flow
-100
10
30
60
60
20

10.00%
Project A
Reinvested @%10
14.641
39.930
72.600
66.000
20.000

Project B
Cash Flow
Reinvested @%10
-100
60
87.846
60
79.860
10
12.100
10
11.000
10
10.000

213.171

200.806

NPV

32.36

24.68

IRR

20.34%

24.21%

MIRR

16.34%

14.96%

MIRR (using excel)

assuming
Reinvestment rate :
Financing rate :

16.34%

14.96%

10.00%
10.00%

10.00%
10.00%

(Method used by Excel)

Reinvestment Rate :

Year
0
1
2
3
4
5
6
7

Cash Flow
-33.33
-33.33
-33.33
10
30
60
60
20

10.00%
Project A
Reinvested @%10

14.641
39.930
72.600
66.000
20.000

Cash Flow
-33.33
-33.33
-33.33
60
60
10
10
10

Project B
Reinvested @%10

87.846
79.860
12.100
11.000
10.000

Terminal Value
PV of Capex

213.17
-91.18

200.81
-91.18

NPV

18.21

11.86

IRR

14.84%

14.68%

MIRR

12.90%

11.94%

MIRR (using excel)

assuming
Reinvestment rate :
Financing rate :

13.03%

12.07%

10.00%
11.00%

10.00%
11.00%

69.29001
0

60.000

NPV is different