BUSINESS FINANCE

ASSIGNMENT
Mathematics for finance problem set:

1. Amount deposited = Rs. 2,50,000

Period = 3 years – 12 times(Since it is compounded quarterly)

Interest = 8% (Compounded quarterly) – 2%

A=C(1+R/100)N

A=250000(1.02)12

A= Rs. 317060

2. A=Rs. 50000

Investment Period = 4 years (at the end of each year)

Interest Rate = 12

A= A1 + A2+A3+A4

A=50000(1.12)3 + 50000(1.12)2 + 50000(1.12) + 50000

A= Rs. 188500

3. Amount to be received after 6 years = Rs. 55,800

Interest Rate = 6%

Amount to be Invested every year = ?

A=P{(1+R)N -1}/R

A=Rs. 8005
4. Amount of Issued debentures = 50,00,000

Interest = 12%

Period = 7 years

Amount to be invested in Sinking Fund(p) =?

A=P{(1+R)N -1}/R

A = 50,00,000

P =Rs. 4.95,589

5. a) We will be incur an immediate expense of Rs. 10,000

b) We will make a payment of Rs. 2310 at the end of each year till 5 years.

So we need to check if the present value of all these payments is less

than 10,000 or not.

Calculating PV: 2310/(1.12) + 2310/(1.12)2 + 2310/(1.12)3 + 2310/(1.12)4

+ 2310/(1.12)5

PV = Rs. 8342.5

Since the Present Value of second payment is lower than the initial
expenditure, so the second option is better.

6. A=P(1+R)N
25
170=10(1+R)

1+R=1.025

Rate of Interest(CAGR) = 2.5%

7. Amount Borrowed = Rs. 50000

Interest rate = 4%

Period = 25 equal yearly instalments

 A=P{1/R – 1/R(1+R)N}

P = Rs.3205

Amount of each instalment should be Rs.3205

8. Nominal rate of Interest(r) = 24%

Effective rate of interest =

a) Half yearly – (1+r/2)2 – 1 = 25.44%

b) Quarterly - (1+r/4)4 – 1 = 26.24%

c) Monthly - (1+r/12)12 – 1 = 26.82%

NPV vs. IRR

Net Present Value

NPV technique explicitly recognizes the time value of money. According to

NPV technique cash flows arising at different time periods differ in value.
Steps involved in calculation of NPV:
• Cash flows of investment project should be forecasted
• Appropriate discount rate should be chosen to discount the forecasted
cash flows
• Present values of cash flows should be calculated using opportunity cost
of capital as the discount rate
• Net present value should be found out by subtracting cash outflows
from present value of cash inflows

Acceptance Rule
NPV>0 – Accept the project
NPV<0 – Reject the project
NPV=0 - Indifferent in accepting or rejecting the project

Internal Rate of Return (IRR)

IRR is another discounted cash flow technique that takes account of

magnitude and timing of cash flows. IRR is the rate that equates
investment outlay with present value of cash inflow received after one
period. IRR can be determined by solving the following equation for r:

Acceptance Rule:
Let k be the required rate or hurdle rate
Accept the project when r > k
Reject the project when r < k
May accept the project r = k

NPV Vs IRR

Case of Conventional Independent Projects

A conventional investment is the one in which cash flows take the pattern
of an initial cash outlay followed by cash inflows. Conventional projects
have only one change in sign of cash flows.
In case of conventional investments, NPV and IRR methods result in same
accept or reject decision. Same project would be indicated profitable by
both the methods. All projects with positive NPV values would be accepted
if the NPV method was followed and similarly all projects whose internal
rate of return would be more than hurdle rate if the IRR method was
followed.

Non Conventional Investments

Case of Ranking Mutually Exclusive Projects
The NPV and IRR may give conflicting ranking to the projects under
following conditions:
• The cash flow pattern of projects may differ
• The cash outlays of projects may differ
• The projects may have different expected lives

However in all the above cases NPV method should be used for ranking of
projects. This is because not only the NPV method gives unambiguous
results but also it is consistent with the wealth maximization principle

CASH FLOW:
1) Xyz is considering replacement of its existing machine by a new
machine which is expected to cost Rs.160000.The new machine will
have a life of 5 years and will yield annual cash revenue of
Rs.250000 and incur annual cash expenses of Rs. 1,30,000. The
estimated salvage value of the new machine is Rs. 8000.The
existing machine has a book value of Rs. 40000, and can be sold for
Rs. 20000 today. It is good for the next five years and is estimated
to generate annual cash flows of Rs.20000 and to involve annual
cash expenses of Rs. 140000. If sold after 5 years, the salvage
value of the existing machine can be expected to be Rs.2000.

A) Initial Investment

Investment in New machine – Rs. -1,60,000

Cash from existing machine – Rs. 20,000
Net cash: Rs. -1,40,000

B) Cash flow from operations

NCF= (EBIT)(1-T) + DEP
NCF = (REV – EXP - DEP)(1-T) + DEP
NCF = [{(250000 – 200000) – (130000 - 140000) – (45000 -
10000)}(1 - .35) + (45000 – 10000)]
NCF = Rs. 51250

C) Terminal Cash flows:

If the company goes for the new machine, it can expect to obtain
a salvage value of Rs. 8000 but it will lose out on Rs.2000 from
the salvage value of existing machine then. Hence, with new
machine, it receives a terminal cash flow of Rs.6000

YEAR 0 1 2 3 4 5
Investment(new -160000
machine)
Salvage 20000
value(existing
machine)
Net cash -140000
Revenue 50000 50000 50000 50000 50000
Expenses 10000 10000 10000 10000 10000
Depreciation 35000 26250 19687 14765 11074
EBIT 25000 33750 40313 45235 48926
EBIT(1-T) 16250 21937 26203 29403 31802
Cash flow from 51250 48187 45890 44168 42876
operations
Salvage value of 8000
new machine
End value of old -2000
machine
Net cash flows -140000 51250 48187 45890 44168 48876
Present value at -140000 42691 33442 26570 21289 19648
20%
NPV 3640

*Depreciation (New asset) is calculated on Depreciation base = 160000 + 40000

– 20000 = 180000