Академический Документы
Профессиональный Документы
Культура Документы
Ex-1
2
3
4
Prob-1
2
3
4
5
6
7
8
9
10
11
Topic Covered
Present value of the project, internal rate of return, payback period
Incremental cash flows, incremental depreciation, PV of salvage value, tax shield, MACRS
Selection of projects with cummulative cash flows, economies realized in combination
NPV resulting from synergism
Payback Period & NPV
Critisism over ARR and payback period
Payback period, profitabilit index, IRR, NPV
IRR & Selection of projects
Selection of purchase of equipment, asset, analysis of various cash flows
Purchase of Equipment, MACRS & NPV analysis
NPV analysis and inclusion of working capital as outflow & its recovery at the end
Capital rationing & selection of the optimal strategy
Earnings after tax, cash flows and NPV analysis
Shortcommings of IRR, application of quadratic equation, dual IRR of a project
Shortcommings of IRR, investment with cash flow pattern having No IRR.
a- If the required rate of return is 15 percent, what is the net present value of the project?
is it acceptable?
b- What is the internal rate of return?
c- What would be the case if the required rate of return were 10 percent?
d- What is the project's payback period?
Q1aYear
0
1
2
3
4
5
6
7
8
9
10
Cash Flows
DF @ 15 %
700,000.00
1.0000
- 1,000,000.00
0.8696
250,000.00
0.7561
300,000.00
0.6575
350,000.00
0.5718
400,000.00
0.4972
400,000.00
0.4323
400,000.00
0.3759
400,000.00
0.3269
400,000.00
0.2843
400,000.00
0.2472
Net Present Value
PV
OR
700,000
869,565
189,036
197,255
200,114
198,871
172,931
150,375
130,761
113,705
98,874
Year
0
1
2
3
4
5-10
117,645
Since the NPV of the project is negative, we will reject it/ Unacceptable
Q1bYear
0
1
2
3
4
5
6
7
8
9
10
Cash Flows
DF @ 13 %
700,000.00
1.0000
- 1,000,000.00
0.8850
250,000.00
0.7831
300,000.00
0.6931
350,000.00
0.6133
400,000.00
0.5428
400,000.00
0.4803
400,000.00
0.4251
400,000.00
0.3762
400,000.00
0.3329
400,000.00
0.2946
PV
DF @ 14 %
700,000
1.0000
884,956
0.8772
195,787
0.7695
207,915
0.6750
214,662
0.5921
217,104
0.5194
192,127
0.4556
170,024
0.3996
150,464
0.3506
133,154
0.3075
117,835
0.2697
PV
- 700,000
- 877,193
192,367
202,491
207,228
207,747
182,235
159,855
140,224
123,003
107,898
14,116
- 54,145
X
0.13
14,116.38
Positive NPV
Negative NPV
0.13
68,261.59
0.21
0.13
0.0021
13.21%
Q1cYear
0
1
2
3
4
5
6
7
8
9
10
Cash Flows
DF @ 10 %
700,000.00
1.0000
- 1,000,000.00
0.9091
250,000.00
0.8264
300,000.00
0.7513
350,000.00
0.6830
400,000.00
0.6209
400,000.00
0.5645
400,000.00
0.5132
400,000.00
0.4665
400,000.00
0.4241
400,000.00
0.3855
Net Present Value
PV
700,000
909,091
206,612
225,394
239,055
248,369
225,790
205,263
186,603
169,639
154,217
251,850
Here the project has positive net present value, hence it becomes acceptable at 10 percent.
Q1dYear
0
1
2
3
4
5
6
7
8
9
10
Additional Working:
Q1c-
Cash Flows
700,000.00
- 1,000,000.00
250,000.00
300,000.00
350,000.00
400,000.00
400,000.00
400,000.00
400,000.00
400,000.00
400,000.00
======>
Year
0
1
2
3
4
5
6
7
8
9
10
Cash Flows
DF @ 10 %
700,000.00
1.0000
- 1,000,000.00
0.9091
250,000.00
0.8264
300,000.00
0.7513
350,000.00
0.6830
400,000.00
0.6209
400,000.00
0.5645
400,000.00
0.5132
400,000.00
0.4665
400,000.00
0.4241
400,000.00
0.3855
Net Present Value
PV
700,000
909,091
206,612
225,394
239,055
248,369
225,790
205,263
186,603
169,639
154,217
Cumm. CF
700,000
- 1,609,091
- 1,402,479
- 1,177,085
938,030
689,662
463,872
258,609
72,006
97,633
251,850
Because of discounted cash flows the pay back period extends from 6 to 8.58 years
of the project?
Cash Flows
$
(700,000.00)
(1,000,000.00)
250,000.00
300,000.00
350,000.00
400,000.00
Net Present Value
e at 10 percent.
riod is 6 years.
0.01
0.01
1
1
1
1
1
1
1
1
0.576
8.58
Years
120,000
96,000
15,000
120,000
153,600
15,000
120,000
92,160
15,000
Incr. Dep
81,000
138,600
77,160
3-
Profit BT
39,000 -
18,600
42,840
4-
Tax @ 34 %
13,260 -
6,324
14,566
5-
106,740
126,324
105,434
6-
7-
106,740
126,324
105,434
8-
DF @ 14%
0.877
93,632
0.769
97,202
0.675
71,165
1120000 28
15000
91011-
Particular
0
Incremental
annual Savings
New Depreciation
Old Depreciation
Cost of machine
Sale of Old Machine
Tax Savings
1.0
- 480,000.00
70,000.00
17,000.00
- 393,000.00
Step-1
Step-2
Step-3
Step-4
Step-5
Step-6
Step-7
Step-8
Step-9
Step-10
of return is 14 percent?
120,000
55,296
15,000
120,000
55,296
15,000
120,000
27,648
15,000
120,000
120,000
15,000
15,000
40,296
40,296
15,000 -
15,000
79,704
79,704
107,352
135,000
135,000
27,099
27,099
36,500
45,900
45,900
92,901
92,901
83,500
74,100
74,100
12,648 -
Total
26,400
92,901
92,901
83,500
74,100
100,500
0.592
55,005
0.519
48,250
0.456
38,042
0.400
29,613
0.351
35,231
-
NPV
Conclusion: Project is acceptable
468,139
480,000
70,000
17,000
75,139
Q3The Platte River Perfect Cooker Company is evaluating three investment situations:
(1) produce a new line of aluminum skillets,(2) expand its existing cooker line to include
several new sizes, and (3) develop a new, higher quality line of cookers. If only the
project in question is undertaken, the expected value and the amounts of investment
required are:
Investment
Present Value of
Project
Required
Future Cash flows
1
200,000.00
290,000.00
2
115,000.00
185,000.00
3
270,000.00
400,000.00
If project 1 and 2 are jointly undertaken, there will be no economies; the investment required
and present values will simply be the sum of the parts. With project 1 & 3 economies are possible
in investment because one of the machines acquired can be used in both production processes.
The total investment required for project 1 & 3 combined is $440,000. If project 2 and 3 are
undertaken, there are economies to be achieved in marketing and producing the product but, not
in investment. The expected present value for future cash flows for project 2 & 3 is $620,000.
If the three projects are undertaken simultaneously, the economies noted will still hold.
however, a $125,000 extension on plant will be necessary, as space is not available for all the three
projects. Which project or projects should be chosen?
Ans3Project 1 & 3
Investment required
PV of Cash Flows
(290000 + 400000)
-440,000.00
690,000.00
250,000.00
Investment required
(115000+270000)
PV of Cash Flows
-385,000.00
235,000.00
Investment required
(115000+440000)
Add. Inv. for extension
-555,000.00
Project 2 & 3
620,000.00
Project 1, 2 & 3
125,000.00
PV of Cash Flows
(620000+290000)
Net Present Value
Conclusion:
910,000.00
230,000.00
Ans4Year
1
2
3
4
5
6
7
8
9
10-25
Cash Flows
$
2,300,000
2,645,000
3,041,750
3,498,013
4,022,714
4,626,122
5,320,040
6,118,046
7,035,753
8,091,115
A
Investment
Net Cash Flows
DF @ 18%
-$
1,000,000 $
1,300,000 0.847458
1,000,000
1,645,000 0.718184
1,000,000
2,041,750 0.608631
1,000,000
2,498,013 0.515789
1,000,000
3,022,714 0.437109
1,000,000
3,626,122 0.370432
1,000,000
4,320,040 0.313925
1,000,000
5,118,046 0.266038
1,000,000
6,035,753 0.225456
1,000,000
7,091,115 1.163884
Net present Value
Conclusion:
Since the present value of the project is positive, it is acceptable
B
Present Value
$
1,101,695
$
1,181,413
$
1,242,672
$
1,288,447
$
1,321,256
$
1,343,230
$
1,356,169
$
1,361,595
$
1,360,797
$
8,253,236
$
19,810,511
Prob1Lobears Inc. is considering two investment proposals, labeled project A and project B,
with the characteristics shown in the accompanying table:
Project A
Profit
Net Cash
Period
Cost
After Tax
Flows
Using DF 0 perfect,
$
25 percent,
9,000.00100$percent and
- 400
$ percent, we have
1
$ 1,000.00 $
5,000.00
2
$ 1,000.00 $
4,000.00
3
$ 1,000.00 $
3,000.00
Cost
$ 12,000.00 $
$
$
$
Project B
Profit
Net Cash
After Tax
Flows
1,000.00 $ 5,000.00
1,000.00 $ 5,000.00
4,000.00 $ 8,000.00
for each project compute its average rate of return, its payback period, and its present value
using a discount rate of 15 percent.
Project A
$
$
1,000.00 =
4,500.00
22.22%
Project B
$
$
2,000.00 =
6,000.00
33.33%
Second Approach
Avg. rate of return =
Project A
$
$
1,000.00 =
9,000.00
11.11%
Project B
$
$
2,000.00 =
12,000.00
16.67%
Cost
0
1
2
3
$
$
$
$
Project-2
Period
Cumm. CF
-9,000 $
-9,000
5,000 $
-4,000
4,000 $
3,000
2 years
0
1
2
3
Cost
Cumm. CF
$ -12,000.00 $ -12,000.00
$ 5,000.00 $ -7,000.00
$ 5,000.00 $ -2,000.00
$ 8,000.00
2.00
0.25
2.25 Years
DF 15%
1
0.870
0.756
0.658
PV
-
9,000
4,348
3,025
1,973
345
Year
0
1
2
3
Cash Flows
- 12,000.00
5,000
5,000
8,000
DF 15%
1
0.870
0.756
0.658
PV
- 12,000
4,348
3,781
5,260
1,389
Prob3Zaire Electronics can make either of the two investments at time 0. Assuming
a required rate of return of 14 percent, determine each project's (a) payback period,
(b) the net present value, ( c ) the profitability index, (d) the internal rate of return.
Assume the accelerated cost recover system for depreciation and that asset falls in
5-year property class and corporate tax rate is 34 percent.
Using DF 0 perfect, 25 percent, 100 percent and 400 percent, we have
Project
Project
Cost
1
2
3
4
A
$ 28,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $ 8,000.00 $
B
$ 20,000.00 $ 5,000.00 $ 5,000.00 $ 6,000.00 $ 6,000.00 $
5
8,000.00 $
7,000.00 $
6
8,000.00 $
7,000.00 $
7
8,000.00
7,000.00
Ans3-
-28000
B
C = (B x Dep )
A
Year
1
2
3
4
5
6
7
Savings
Depreciation
8000
-5600
8000
-8960
8000
-5376
8000
-3225.6
8000
-3225.6
8000
-1612.8
8000
Savings
1
2
3
4
5
6
7
5000
5000
6000
6000
7000
7000
7000
E = D x Tax
F=B-E
Tax
Cash Flows
7,184
8,326
7,108
6,377
6,377
5,828
5,280
EBT
2400
-960 2624
4774.4
4774.4
6387.2
8000
-20000
B
C = (B x Dep )
A
Year
D = B-C
D = B-C
Depreciation
-4000
-6400
-3840
-2304
-2304
-1152
816
326
892
1,623
1,623
2,172
2,720
E = D x Tax
EBT
Tax
1000
-1400 2160
3696
4696
5848
7000
340
476
734
1,257
1,597
1,988
2,380
F=B-E
Recovery
Year
3-Year
Property
1
2
3
4
5
6
Recovery
Year
Cash Flows
4,660
5,476
5,266
4,743
5,403
5,012
4,620
0.2
0.32
0.192
0.1152
0.1152
0.0576
20
32
19.2
11.52
11.52
5.76
3-Year
Property
1
2
3
4
5
6
0.2
0.32
0.192
0.1152
0.1152
0.0576
20
32
19.2
11.52
11.52
5.76
Cash Flows
- 28,000.00
7,184
8,326
7,108
6,377
6,377
5,828
5,280
Year
0
1
2
3
4
5
6
7
Cash Flows
- 20,000.00
4,660
5,476
5,266
4,743
5,403
5,012
4,620
3.84 Years
Cash Flows
- 28,000.00
7,184
8,326
7,108
Cumm. C.F
- 20,000.00
- 15,340.00
- 9,864.00
- 4,598.40
3.97 Years
PV
28,000
6,302
6,407
4,798
Year
0
1
2
3
Cash Flows
- 20,000.00
4,660
5,476
5,266
DF 14%
1
0.877
0.769
0.675
PV
20,000
4,088
4,214
3,554
4
5
6
7
6,377
6,377
5,828
5,280
0.592
0.519
0.456
0.400
3,776
3,312
2,655
2,110
4
5
6
7
4,743
5,403
5,012
4,620
0.592
0.519
0.456
0.400
1,359
1,600
Ans3cProfitability Index =
Project A
29,359
28,000
Project B
1.05
Cash Flows
- 28,000.00
7,184
8,326
7,108
6,377
6,377
5,828
5,280
DF 15%
1
0.870
0.756
0.658
0.572
0.497
0.432
0.376
PV
28,000
6,247
6,296
4,674
3,646
3,170
2,520
1,985
537
DF 16%
1
0.862
0.743
0.641
0.552
0.476
0.410
0.354
PV
28,000
6,193
6,188
4,554
3,522
3,036
2,392
1,868
247
0.15
21,600
20,000
1.08
537.39 X
0.01
0.15
784.47
0.69 X
0.01
0.15
0.0069
15.69%
2,808
2,806
2,283
1,846
0
1
$ -10,000.00 $ 5,000.00 $
$ -10,000.00 $
$
2
3
4
5,000.00 $ 5,000.00 $ 5,000.00
$
$ 30,000.00
Year
0
1
2
3
4
Cash Flows
- 10,000.00
5,000
5,000
5,000
5,000
DF 34%
1
0.746
0.557
0.416
0.310
PV
10,000
3,731
2,785
2,078
1,551
145
DF 35%
1
0.741
0.549
0.406
0.301
Higher Rate
0.34
145 X
Positive NPV
Negative NPV
0.34
160
0.90 X
0.34
0.0090
34.90%
Cash Flows
- 10,000.00
30,000
DF 31%
1
0.763
0.583
0.445
0.340
PV
10,000
10,187
DF 32%
1
0.758
0.574
0.435
0.329
187
IRR = A + (a/b) X (b-a)
Lower Rate
Higher Rate
Positive NPV
Negative NPV
0.31
187 X
0.31
0.31
+
+
305
0.61 X
0.0061
31.61%
Year
0
1
2
3
4
Cash Flows
- 10,000.00
5,000
5,000
5,000
5,000
DF 10%
1
0.909
0.826
0.751
0.683
PV
10,000
4,545
4,132
3,757
3,415
5,849
Ans4c-
Summary
Project
A
B
NPV
5,849
10,490
IRR
34.90%
31.61%
On theoretical grounds, we will accept project B having higher present value in absolute terms.
Where it is assumed that appropriate reinvestment rate is the discount rate of 10 percent.
However, on practical grounds, IRR has preference. The difference in answers is due to different rates implied for PV and IRR.
PV
- 10,000
3,704
2,743
2,032
1,505
-
15
0.01
0.01
PV
- 10,000
9,882
118
0.01
0.01
Year
0
1
2
3
4
Cash Flows
- 10,000.00
30,000
DF 10%
PV
1
- 10,000
0.909
0.826
0.751
0.683
20,490
10,490
Prob5The city of San Joe needs a number of new special purpose trucks. It has received several bids
and has closely evaluated the performance characteristics of various trucks. Each petter bit truck
costs $74,000, but, it is "Top-of-the-line" equipment, The truck has a life of 8 years. Assuming that
the engine is rebuilt in the fifth year. Maintenance costs of $2,000 are expected a year in the first
four years, followed by total maintenance and rebuilding costs of $13,000 in the fifth year.
During the last three years Maintenance costs are expected to be $4,000 a year. At the end of 8 years,
the truck will have an estimated scrap value of $9,000.
A bid from the Bulldog Truck, Inc., is for $59,000 a truck, However, maintenance costs for this truck
will be higher. In the first year they are expected to be $3,000 and this amount is expected to
increase y $1,500 a year through the eighth year. In the fourth year, the engine need a rebuilt, and
this will cost the company $15,000 in additional to maintenance costs in that year. At the end of 8
years, the bulldog truck will have an scrap value of $5,000.
The last bid, Best Tractor and Trailer Company, has agreed to sell San Joe at $44,000 each. Maintenance
costs in the first 4 years are expected to be $4,000 the first year and are expected to increase by $1,000
a year. For San Joe's purpose the truck has a life of only 4 years. At that time it can be traded-in for a
new Best Truck, which is expected to costs $52,000. The likely traded-in value of the old truck is $15,000.
During years 5 through 8, the second truck is expected to have a maintenance costs of $5,000 in year 5,
and these are expected to increase by $1,000 each year. At the end of 8 years, the second truck is expected
to have a resale salvage value of $18,000.
a- If the San Joe's costs of funds is 8 percent, which bid should it accept? Ignore any tax considerations as
the city pays no taxes.
b- If it opportunity costs were 15 percent, would you answer change?
Ans5a
Year
0
1
2
3
4
5
6
7
8
8
PV
Year
74,000
0
1,852
1
1,715
2
1,588
3
1,470
4
8,848
5
2,521
6
2,334
7
2,161
8
4,862
8
Bulldog truck
Cash Flows DF 8%
59000
1
3000 0.926
4500 0.857
6000 0.794
22500 0.735
9000 0.681
10500 0.630
12000 0.583
13500 0.540
-5000 0.540
91,625
PV
Year
59,000
0
2,778
1
3,858
2
4,763
3
16,538
4
6,125
5
6,617
6
7,002
7
7,294
8
2,701
8
Best Truck
Cash Flows DF 8%
44000
1
4000 0.926
5000 0.857
6000 0.794
44000 0.735
5000 0.681
6000 0.630
7000 0.583
8000 0.540
-18000 0.540
111,273
PV
44,000
3,704
4,287
4,763
32,341
3,403
3,781
4,084
4,322
- 9,725
94,960
Petter Bit Truck should be selected having the lowest PV of cash outflows
Ans5b
Year
0
1
2
3
4
5
6
7
8
8
PV
Year
74,000
0
1,739
1
1,512
2
1,315
3
1,144
4
6,463
5
1,729
6
1,504
7
1,308
8
2,942
8
Bulldog truck
Cash Flows DF 15%
59000
1
3000 0.870
4500 0.756
6000 0.658
22500 0.572
9000 0.497
10500 0.432
12000 0.376
13500 0.327
-5000 0.327 -
87,772
PV
Year
59,000
0
2,609
1
3,403
2
3,945
3
12,864
4
4,475
5
4,539
6
4,511
7
4,413
8
1,635
8
Best Truck
Cash Flows DF 15%
PV
44000
1
44,000
4000 0.870
3,478
5000 0.756
3,781
6000 0.658
3,945
44000 0.572
25,157
5000 0.497
2,486
6000 0.432
2,594
7000 0.376
2,632
8000 0.327
2,615
-18000 0.327 - 5,884
98,125
84,804
Thoma Pharmaceutical Company may buy DNA testing equipment costing $60,000.
This equipment is expected to reduce clinical staff labor cost by $20,000 annually.
The equipment has a useful life of 5 years, but, falls into 3 years property class for
cost recovery (depreciation) purposes. No salvage value is expected at the end. The
corporate tax rate for Thoma is 38 percent, and its required rate of return is 15 percent.
(If profits before tax are negative in any year, the firm will receive a tax credit of 38
value of the project? Is it acceptable?
Ans6Years
0
1
2
3
4
5
Outlay/
Savings
60,000
20,000
20,000
20,000
20,000
20,000
Dep
0
-19998
-26670
-8886
-4446
EBT
0
2
-6670
11114
15554
20000
Tax
0
1
-2535
4223
5911
7600
Cash Flow
-60000
19999
22535
15777
14089
12400
DF
1
0.870
0.756
0.658
0.572
0.497
Recovery 3-Year
Year
Property
1
33.33
2
44.45
3
14.81
4
7.41
0.3333
0.4445
0.1481
0.0741
PV
- 60,000
17,391
17,039
10,373
8,056
6,165
-
976
Ans7aYears
0
1
2
3
4
5
Cash Flows
-60000
20000
21200
22472
23820
25250
Dep
-19998
-26670
-8886
-4446
EBT
2
-5470
13586
19374
25250
Tax
1
-2079
5163
7362
9595
Cash Flow
-60000
19999
23279
17309
16458
15655
DF
1
0.870
0.756
0.658
0.572
0.497
PV
- 60,000
17,391
17,602
11,381
9,410
7,783
3,567
Ans7bYears
0
1
2
3
4
5
5
Cash Flows
-70000
20000
21200
22472
23820
25250
10000
Dep
-19998
-26670
-8886
-4446
EBT
2
-5470
13586
19374
25250
Tax
1
-2079
5163
7362
9595
Cash Flow
DF
-70000
1
19999 0.870
23279 0.756
17309 0.658
16458 0.572
15655 0.497
10000 0.497
Net Present Value
PV
- 70,000
17,391
17,602
11,381
9,410
7,783
4,972
- 1,461
Prob8The lake Thoe Ski Resort is studying a half-dozen of capital improvement projects.
It has allocated $1 million for capital budgeting purposes. The following proposals
and associated profitability indexes have been determined. The projects themselves
are independent of on an another.
Profitability
Project
Amount
Index
Extend Ski lift 3
500,000
1.21
Build a new sports shop
150,000
0.95
Extend Ski lift 4
350,000
1.2
Build a new restaurant
450,000
1.18
Add to new housing complex
200,000
1.2
Build an indoor skating rink
400,000
1.05
S.No.
1
2
3
4
5
6
Project
Extend Ski Lift 3
Build a new sports shop
Extend Ski lift 4
Build a new restaurant
Add to new housing complex
Build an indoor skating rink
Amount
500,000.00
150,000.00
350,000.00
450,000.00
200,000.00
400,000.00
Profitability
Index
1.21
0.95
1.20
1.18
1.20
1.05
Cash Flow
605000
142500 420000
531000
240000
420000
Present Value
105,000.00
7,500.00
70,000.00
81,000.00
40,000.00
20,000.00
605000
420000
Present Value
105,000.00
70,000.00
Selecting project with the highest Profitability Index and present Value
S.No.
1
3
Project
Extend Ski Lift 3
Extend Ski lift 4
Amount
500,000.00
350,000.00
Profitability
Index
1.21
1.20
Cash Flow
850,000.00
175,000.00
However, it would be better to utilize the full budget, even though the most profitable project
is foregone
S.No.
3
4
5
Project
Extend Ski lift 4
Build a new restaurant
Add to new housing complex
Amount
350,000.00
450,000.00
200,000.00
Profitability
Index
1.20
1.18
1.20
Cash Flow
1,000,000.00
This is going to maximize the full budget and thus, results in higher cumulative present value.
Ans8b
No, The optimal strategy is one that all the projects. If there is capital rationing problem, then a higher
discount rate should be used to assess the projects and that more accurately reflects the costs of financing
420000
531000
240000
Present Value
70,000.00
81,000.00
40,000.00
191,000.00
Prob9The R.Z Frank Company may acquire Aziz Car Leasing Company. Frank estimates
that Aziz will provide incremental net income after taxes of $2 million in the
first year, $3million in the second year, $4 million in the third year, $5 million in each of the
year 6 through 6, and $6 million annually thereafter. Owning the need to replenish the
fleet, heavier than usual investments are required in the first 2 years. Capital Investment
and depreciation charges are expected to be (in millions):
Years
Capital Investment
Depreciation
1
5
3
2
5
4
3
4
4
4
4
4
5
4
4
6
4
4
DF
0.870
0.756
0.658
0.572
0.497
0.432
2.882
Present Value
1,512,287
2,630,065
2,858,766
2,485,884
2,161,638
17,293,104
The overall required rate of return is 15 percent. Compute the present value of acquisition based
on these expectations. If you had a range of possible outcomes, how would you obtain the information
necessary to analyze the acquisition?
Year
1
2
3
4
5
6
7 ON
EAT
2,000,000
3,000,000
4,000,000
5,000,000
5,000,000
5,000,000
6,000,000
Dep
3,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
Cash Flows
5,000,000
7,000,000
8,000,000
9,000,000
9,000,000
9,000,000
10,000,000
Cap. Inv
5,000,000
5,000,000
4,000,000
4,000,000
4,000,000
4,000,000
4,000,000
Present Value
2,000,000
4,000,000
5,000,000
5,000,000
5,000,000
6,000,000
Net Present Value
Additional Notes:
We can more thoroughly assess the investment if the risk-free rate is used.
This will reduce the risk of double counting.
The expected values of the probability distribution of possible present values
is a weighted average i.e. Probability of occurrence X adjusted present values)
Also Standard deviation may also be calculated from the information given and
the profitability of the investment may be assessed.
28,941,744
7 ON
4
4
Prob10An investment has an outlay of $800 today, an inflow of $5,000 at the end of 1 year,
and an outflow of $8,000 at the end of 2 years. What is its internal rate of return?
if the initial outlay were $1,250, what would be the IRR? (This problem is an exception
rather than the rule)
Ans10A-
1
(1+ r)
1
(1+ r)
2000
10000
1
(1+ r)
0.2
5 =
400%
1
(1+ r)
-8000
10000
1
(1+ r)
-0.8
1.25 =
25%
The Problem highlights one of the shortfalls in IRR investment appraisal analysis
Dual IIR exists for the problem of 400% and 25 %
Ans10A-
1
(1+ r)
5000
10000
1
(1+ r)
0.5
2 =
-5000
100%
(1+ r)
10000
1
(1+ r)
-0.5
2 =
100%
if the initial investment were $1,250, instead of $800, we see unique IRR
Prob11An investment has a cash flow of $200 today, an out flow of $300 at the end of
1 year , an inflow of $400 at the end of 2 years. What is the internal rate of return?
Ans11We can try multiple discount factors here to see their impact
300
216
150
DF
=1/(1)
=1/((1+1)^1)
=1/((1+1)^2)
DF
=1/(1)
=1/((1+4)^1)
=1/((1+4)^2)
156
Conclusion:
At all the interest rates, present values of cash inflow exceeds the present value
of cash outflows, so there is no internal rate of return.