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ROLL.NO. : 520850852
SEMESTER : I / II / III / IV
Decision rule
After ranking various investments proposals on basis on net present value,
projects with negative net present value (net present value of cash inflows
less than their original costs) are rejected and projects with positive NPV are
considered acceptable. In case of mutually exclusive alternative projects,
projects with higher net present value are selected. Net present value method
is suitable for evaluating projects where cash flows are uneven.
Merits
2. The second and more serious problem associated with present value
method is that it involves calculations of the required rate of return to
discount the cash flows. The discount rate is the most important element
used in the calculation of the present value because different discount rates
will give different present values. The relative desirability of a proposal will
change with the change of discount rate. The importance of the discount rate
is thus obvious. But the calculation of required rate of return pursuits serious
problem. The cost of capital is generally the basis of the firm's discount rate.
The calculation of cost of capital is very complicated. In fact there is a
difference of opinion even regarding the exact method of calculating it.
4. The present value method may also give satisfactory results in case
of two projects having different effective lives. The project with a shorter
economic life is preferable, other things being equal. It may be that, a project
which has a higher present value may also have a larger economic life, so
that the funds will remain invested for longer period while the alternative
proposal may have shorter life but smaller present value. In such situations
the present value method may not reflect the true worth of alternative
proposals. This method is suitable for evaluating projects whose capital
outlays or costs differ significantly.
Evaluation of IRR
(c) The results under DFC rate approach are simpler for the
management to understand and appreciate. We should however be very
careful in applying the decision rules properly when NPV and IRR
calculation shows divergent results. The rules are -
(i) the projects be the basis of decision when mutually exclusive in
character;
(ii) there is capital rationing situation
(d) IRR should be a better guide when there are plenty of project
situations (as it is there in a long enterprise) and no major constraints (for
example, in respect of macro projects).
machine A. Rs. 22.0968 will be recovered in 2nd year & balance 17.9032(40-
22.0968) will be recovered in 3rd year out of 23.489
=2year + (17.9032/23.489)
=2year +0.7621
=2.76year
machine A. Rs. 74.4936 will be recovered in 2nd year & balance -34.4936
(40- 74.4936) will be recovered in 3rd year out of 95.8436
=2year + (-34.4936/95.8436)
=2year + -0.3598
= 1.64year
ANS:-
Year Cash flows (inflows) Rs. PV Factor at 9% PV of Cash flows (in flows)
1 9,000 0.9174 8,257
2 8,000 0.8417 6,734
3 7,000 0.7722 4,959
4 12,000 0.7084 8,501
5 21,000 0.6499 13,649
PV of Cash in flows 42,100
PV of Cash outflows 50,000
NPV Negative (7,900)
ANS:-
PARTICULARS JAN FEB MARCH APRIL
Opening cash balance 20,000 25,000 25,000 25,000
Collection from customer 1,30,000 1,60,000 1,65,000 2,30,000
1,50,000 1,85,000 1,90,000 2,55,000
Payments:
Raw materials purchase 25,000 45,000 40,000 63,200
Salary and Wages 1,00,000 1,05,000 1,00,000 1,14,200
Other expenses 15,000 10,000 15,000 12,000
Income Tax 6,000 --- --- ---
Machinery --- --- 20,000 ---
1,46,000 1,60,000 1,75,000 1,89,400
Closing balance 4,000 5,000 15,000 65,600
For JAN:
Bank over Draft 21,000 for maintain minimum cash balance for month of
February 21000+4000=25000.
For FEB:
No need to take bank over Draft because closing balance 25,000.
For MARCH:
Bank over Draft 10,000 for maintain minimum cash balance for month of
April 15,000+10,000=25000.
At last closing balance month of April 65,600 so return to bank 31,000 form month
of april , 65,600 – 31,000= 34,400