9.

13 a P0=D/I 35
b Yes.Undervalued

9.15 pv
g= 0.07
Ke= 0.18 P0(PVofP4+PV of Div)
Year D0 2.5 2.5 $24.32
1 D1 2.68 $2.27
2 D2 2.86 $2.06
3 D3 3.06 $1.86
4 D4 3.28 $1.69 P4= 31.88 PV $16.44
5 D5 3.51

Growth 0.3 0.28 0.24 0.08 0.08

9.16 Year 1 2 3 4 5
D0 D1 D2 D3 D4 D5
Div 1.67 2.17 2.78 3.45 3.72 4.02
Pv of Div $1.90 $2.14 $2.33 $2.20 $2.09
P3 62.024602
P0 $48.23
P0(CGM)
24.32
 Tax rate is 25%

Year EBIT Depreciation Capex

Rs Cr Rs Cr
to 150 23 56
FCFF= 66.5

Tax rate is 25%

Year EBIT Depreciation Capex

Rs Cr Rs Cr
1 150 23 56
2 170 28 78
3 210 35 65

FCFF (1)
FCFF (2)
FCFF (3)
FCFF (1) 66.5
FCFF (2) 43.5
FCFF (3) 137.5

This could be historical or forecasted.

Tax rate is 25%

Year PAT Depreciation Capex

Rs Cr Rs Cr
1 100 23 56
FCFE= 53

Tax rate is 25%

Year PAT Depreciation Capex

Rs Cr Rs Cr
1 100 23 56
 2 120 28 110
3 90 35 65

FCFE(1)=
FCFE(2)=
FCFE(3)=

FCFE(1)= 53
FCFE(2)= -2
FCFE(3)= 72
change in WC
Rs Cr
13

change in WC
Rs Cr
13
34
-10
 Debt Debt
change in WC raised repaid
Rs Cr Rs Cr Rs Cr
13 10 11

Debt Debt
change in WC raised repaid
Rs Cr Rs Cr Rs Cr
13 10 11
 34 5 11
-10 11 9
 March 31,2015 2018 2017 2016 2015
Tax=25%

Capex,
Depreciation,N
FCFF OP CWC Every year Every year Every year Every year

Capex,
Depreciation,N
CWC,Debt
paid,Debt
FCFE PAT raised Every year Every year Every year Every year

Let us assume

Tax=25% March 31,2015 2014 2013 2012 2011

Rs cr Rs cr Rs cr Rs cr Rs cr
FCFF 100 90 80 110 80
FCFE 95 85 75 102 72

2015 2014 2013 2012 2011 2010

Rs cr Rs cr Rs cr Rs cr Rs cr Rs cr
FCFF 100 90 80 110 80 75
FCFE 95 85 75 102 72 67
Growth
FCFF 0.11 0.13 -0.27 0.38 0.0667 NA
FCFE 0.12 0.13 -0.26 0.42 0.07 NA
Average 0.081 FCFF
Average 0.096 FCFE
Assuming this growth is constant till ever and Ke=13% and Ko=10%
Then, Using Gordon's constant growth model
2016
Rs Cr
FCFF 108.10
FCFE 104.07

Value of firm= FCFF(2016)/(Ko-g)

Value of equity= FCFE(2016)/(Ke-g)

Rs Cr
Value of firm= FCFF(2016)/(Ko-g) 5692.55 Value of firm
Value of equity= FCFE(2016)/(Ke-g) 3017.82 Value of all equity shares
Growth
FCFF #REF! #REF! #REF! #REF! #REF! NA
FCFE #REF! #REF! #REF! #REF! #REF! NA
GM #REF! FCFF
GM #REF! FCFE

Assuming this growth is constant till ever and Ke=11% and Ko=9%
Then,
2016
Rs Cr
FCFF #REF!
FCFE #REF!

Rs Cr
Value of firm= FCFF(2016)/(Ko-g) #REF!
Value of equity= FCFE(2016)/(Ke-g) #REF!
 2014 2013

Every year Every year

Every year Every year

2010
Rs cr
75
67
d Ko=10%

l equity shares
d Ko=9%
The forecasted Cashflows and discount rate can be moderated in the light of new information.

A company expects that’s its cash flows would be as follows:

2018 2019 2020 2021 2022 2023

Rs cr Rs cr Rs cr Rs cr Rs cr Rs cr
FCFF 100 90 80 110 80 75
Certain CF
(based on risk
premium) 96 87 77 106 77 72
Certain CF
(based on CE
0f 80%) 80 72 64 88 64 60

Certain CF
(based on CE
0f 150%) 150 135 120 165 120 113

The company's economist is of the opinion that based on the past trend,the cashflows should be used on the
basis of CERTAINITY EQUIVALENT.
The rate of interest on an investment of similar risk is 11% and risk free rate is 7%.
CE(cash flow)= Cash flow/(1+risk premium)
Risk Prm 0.04

Another economist of the firm is of the opinion that the forecasted cashflows are risky and that CE will be 80%.
One value of certainity equivalent maybe used or separate value maybe used for each year.
CE=Expected Cashflow/Risky Cashflow
2018 2019 2020 2021 2022 2023
Rs cr Rs cr Rs cr Rs cr Rs cr Rs cr
FCFF 100 90 80 110 80 75
CE 0.8 1.1 0.6 0.5 0.5 0.5
Certain CF
(based on CE) 80 99 48 55 40 37.5
After calculating the certain cashflows using different parameters, a call may be taken to use which cashflow or
average and appropriate discount rate maybe used.

The government forecasts a slowdown in economy and thus the CEO is of the opinion that we should be
conservative in using discount rate and increase it by 1%. The cost of capital is 12%.
For discount 'Forecasted' cashflows use 13% rather than 12%.
This is known as Risk Adjusted Discount Rate (RADR).
For risk adjustment in capital budgeting,EITHER use CE or RADR.
uld be used on the

that CE will be 80%.

e which cashflow or

we should be
A machine is to be purchased for two years. Cost is 20000 and cost of capital is 12%
CF1 Proba CF2
8000 0.5
10000 0.4 12000 0.5

12000 0.6 16000 0.4

20000 0.6
Accept or reject ?

Step 1: PV of all Cashflows

Step 2: Find NPV for each Path
Step 3: Find Joint Probability for each path
Step 4: Find Expected NPV for each path (NPV* JP)
Step 5: Add ENPV of all paths to find ENPV of project
Note: Sum of JP should be 1

0.5 NPV Path Joint P

8928.57143 8000 $6,378 ($4,694) 0.2
0.4
10000 12000 $9,566 ($1,505) 0.2
0.5
-20000 0.4 0.24
12000 16000 $12,755 $3,469
0.6 0.36
10714.2857 20000 $15,944 $6,658
0.6
Total 1

Equipment buying. Cost is 245700.

Assume 12% discount rate
 0.7
122800
0.5
153500 184300
0.3
-245700 0.4
125000 240500
0.5
307000
0.6

a. What is the equipment's expected net present value?

b. If the worst outcome occurs, what would be the NPV?

c. If the best outcome occurs, what would be the NPV?

d. In which scenario NPV would be negative and with how much probability.

0.7 NPV Path Joint P

137054 122800 $97,895 ($10,751) 0.35
0.5
153500 184300 $146,923 $38,276 0.15
0.3
-245700 0.4 0.2
125000 240500 $191,725 $57,632
0.5 0.3
111607 307000 $244,739 $110,646
0.6
Total 1
cost of capital is 12%

Path ENPV
($939)

($301)

$833

$2,397

1990
Path ENPV
($3,763)

$5,741

$11,526

$33,194

46699
 Year 1 Year 2 Year 3 Year 4
Probability
0.5 High 12.5 12.5 12.5 12.5
L 0.4 Medium 10 10 10 10
-50 0.1 Low 5 5 5 5

Decision(L or S)
Year 1 Year 2

High
-30 Medium
S 0.5 High 8 8 Low
-20 0.4 Medium 8 8
High PV of 30L(third year) $22.54 0.1 Low 4 4
Medium PV of 15L(third year) $11.27 High
-15 Medium
Low

Year 1

8
8
8
8
8
8

4
Year 5 Year 6 Year 7 Year 8 Year 9 Year 10 NPV ENPV(Path) Project NPV
$41.05
12.5 12.5 12.5 12.5 12.5 12.5 $26.81 $13.40
10 10 10 10 10 10 $61.45 $24.58

5 5 5 5 5 5 $30.72 $3.07

Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

0.6 14 14 14 14 14 14 14 14
0.3 11 11 11 11 11 11 11 11
0.1 8 8 8 8 8 8 8 8

0.6 11 11 11 11 11 11 11 11
0.3 8 8 8 8 8 8 8 8
0.1 2 2 2 2 2 2 2 2

1 4 4 4 4 4 4 4 4

Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10

8 14 14 14 14 14 14 14 14
8 11 11 11 11 11 11 11 11
8 8 8 8 8 8 8 8 8
8 11 11 11 11 11 11 11 11
8 8 8 8 8 8 8 8 8
8 2 2 2 2 2 2 2 2

4 4 4 4 4 4 4 4 4
NPV JP ENPV(Path) Project NPV

22.96
33.07 0.3 9.92
19.84 0.15 2.98
6.62 0.05 0.33

31.11 0.24 7.47

17.89 0.12 2.15
-8.57 0.04 -0.34

4.58 0.1 0.46

Total JP 1

NPV

$33.07
$19.84
$6.62
$31.11
$17.89
($8.57)

$4.58
 2015 2014 2013 2012 2011 2010
Rs cr Rs cr Rs cr Rs cr Rs cr Rs cr
FCFF 100 90 80 110 80 75
FCFE 95 85 75 102 72 67
Growth
FCFF 0.11 0.13 -0.27 0.38 0.07 NA
FCFE 0.12 0.13 -0.26 0.42 0.07 NA
GM 0.0592 FCFF
GM 0.0723 FCFE

Assuming this growth is constant for 3 years and then it increases by 1

Then, Ke= 0.115 Ko= 0.085

2016 2017 2018 2019 TV(2018)

FCFF 105.92 112.2 118.84 127.07
FCFE 101.87 109.24 117.14 126.79
FCFF Present Values 97.624 95.305 93.041
Present Values 6217.6 7941.671
Total PV=Value of firm 6503.6 Rc Cr

2016 2017 2018 2019 TV(2018)

FCFE Present Values 91.365 87.869 84.506
Present Values 2799.9 3881.2137
Total PV=Value of equity 3063.6 Rc Cr
n it increases by 1% till ever