Capital budgetingMini case study

Presented byNIDHI SINGH

PRIYANKA PANDEYSAPNA SHAHI

SHUBHI SRIVASTAVANITISH SINGH

Introduction Aman ltd. Is a manufacturer of automative component. Its projects typically have a short life as it introduces

new models periodically.

There are three projects a, b & c which needs to be analysed by financial analyst that which project is better.

Project A is an extension of an existing line. its cash flow decreases over time.

Project B involves a new product. Its cash flow increases over time.

Project C will sponsor a pavilion at a trade fair. its cost will give huge benefit for 1st yr .

EXPECTED CASH FLOW OF THREE PROJECTS

year PROJECT A PROJECT B PROJECT C

0 (15000) (15000) (15000)

1 11000 3500 42000

2 7000 8000 (4000)

3 4800 13000 -

Q(A): what is pay back period and discounted payback period ?

The payback period is the length of time required to recover the initial cash outlay on the project.

Shorter payback period is most desirable. For ex. If a project involves a cash outlay of

8,00,000 and yield in 4 years then it will be its payback period as total sum is recovered in 4 years and its equal to initial cash outlay.

DISCOUNTED PAYBACK PERIOD Discounted payback period helps to overcome the

limitations where conventional payback period does

not take into account the time value of money. In this method ,cash flows are first converted into

their present value (by applying suitable discounting factors)and then added to ascertain the period of time required to recover the initial outlay on project.

Q: Find the payback periods and the discounted payback periods of project A,B and C.?

PBA = 1+ 4000/7000 = 1+.57 =1.57 PBB = 2+3500/13000 = 2+.27 = 2.27

Discounted payback period

years Discounted payback A Discounted payback B

0 (15000) (15000)

1 11000/1.12=9821.4 3500/1.12=3125

2 7000/(1.12)2=5600 8000/(1.12)2=6400

3 4800/(1.12)3=3428.57 13000/(1.12)3=9285.71

Discount payback

DPBA=1+5178.6/5600

=1+.92

=1.92

DPBB=2+5475/9285.71

= 2+.59

=2.59

what is net present value? what are the properties of NPV?

The NPV of a project is the sum of the present

values of all the cash flows of the project .A project is worthwhile if its NPV>0 otherwise not.

properties Net present values are additive. Intermediate cash flows are invested at the cost

of capital. NPV calculation permits time varying discount

rates.

Q: Calculate the NPV,s of projects A,B and C?

NPV of project A = sum where t=1 Ct/(1+r)n-initial investment

=11000/(1.12)+7000(1.12)2+4800(1.12)3-15000

=9821.4+5600+3428.57-15000

NPVA=18849.9- 15000

= 3849.97

NPVB=3500/1.12+8000/(1.12)2+13000/(1.12)3-15000

= 18810.71-15000

=3810.71

NPVc= 4200/(1.12)+4000(1.12)2+15000

= 37500 – 3200 – 15000

= 25700

Q:What is internal rate of return(IR)?What are the problems with IRR?

The internal rate of return of a project is the

discount rate which makes its NPV equal to 0. A project is worthwhile if its IRR exceeds the cost of capital.

Problems with IRR Non conventional cash flows Mutually exclusive projects Lending vs borrowing

Q: Calculate the IRRs for projects A,B and C?

IRR is the value of R which satisfies the following equations.

15000 = 11000/(1+r) + 7000/(1+r)2 + 4800/(1.28)3Project A

1)Put R=28%11000/(1+r) + 7000/(1+r)2 + 4800/(1.28)3=8593.75+4268.29+2285.71=15147.75

2) Put R=29%11000/(1.29)+7000/(1.29)2+4800/(1.29)3=8527.13+4216.87+2232.56=14976.56

Hence the IRR is :=28+.29/15147.75 - 14976.56=28+.29/171.25

28.30 approx.Project B) Put R=24%= 3500/(1.24)+8000/(1.23) 2+13000/(1.24)3

=2822.58+5194.81+6806.28=14823.672)Put r = 23%=3500/(1.23)+8000/(1.24)2 +13000/(1.24)3

=2845.5+5298.01+6989.25=15132.76

Hence IRR is :

= 23+.24/15132.76-14823.67

=23+.24/309.0

=23.3 approx.

Part c:

Q(D):What is MIRR? what are pros and cons of MIRR vis-à-vis IRR and NPV?

A percentage measure that overcomes the shortcomings of the regular IRR is known as MIRR.

IRR PROS AND CONS

Pros cons

Closely related to NPV may lead to multiple Easy to understand rates of return

may result into incorrect decisions comparing exclusively projects

MIRR PROS AND CONS

PROS CONS If the mutually exclusive if differs in size there

projects are of same size

NPV and IRR lead to same decision

irrespective of variations in life

is a possibility of conflict

Q: Calculate the MIRR,s for projects A,B and C assuming that the intermediate cash flows can be reinvested at 12% rate of return?A)The future values of benefits when compounded 12% = 11000* (1.12)2+ 7000*(1.12)+4800*(1.12)0=13798.4+7840+4800=26438.4Pvc= TVA /(1+ MIRR)n The MIRR is obtained as follows:15000=26438.4/(1+MIRR)3(1+ MIRR)3 = 26438.4/150001+MIRR = (1.76)1/3 = .586MIRR=.586-1 = -.414 or 41.4%

b) The value of benefit when compounded at 12% is

= 3500 * (1.12)2+8000*(1.12)1+13000*(1.12)0

=4375+8960+13000

=26335.00

PVC = TVB/(1+MIRR)n

15000=26335/(1+MIRR)n

(1+MIRR)n= 26335/15000=(1.75)1/3

MIRR=.583-1

=-0.417 or 41.7%

Project c) The future value of benefit when compounded at 12% is

= 42000 * (1.12)2+4000(1.12)1

=52684.8 + 4480

= 57164.8

PVC = TVc/1+MIRRn

The MIRR is obtained as follows:15000= 57164.8/(1+MIRR)3

(1+MIRR)3 = 57164.8/150001+MIRR=(3.81)1/3

MIRR =1.270-1=.27 or 27%