The Financial Analysis of Projects course

provides a set of analytical theory and

practical tools needed to evaluate the financial
feasibility of some investments.
Accounting, risk management, taxation,
capital cost, externalities and organizational
issues influencing the financial viability of
projects will also be analyzed and evaluated.
Time line - Points and periods:
• Base Year / Year zero: A base year is the year
used for comparison for the level of a
particular economic index ( Westopedia)
• Investment Year - Year in which the actual
investment occurs.
• Analysis Period - Period of time for which an
evaluation is conducted
- Depreciation Period - Period of time over which
an investment is amortized

- Levelization Period - Period of time used

when calculating a levelized cash flow stream

- Discount rate: The discount rate also refers to

the interest rate used in discounted cash flow
analysis to determine the present value of
future cash flows ( Westopedia)
A timeline provides a tool for visualizing cash flow and time

Two Cash Flows : An Initial TD20000 Outflow

and 27209,78 Inflow at the end of the 4th year
What is the difference between simple interest
and compound interest?
Simple interest: Interest is earned only on the
principal amount.
Compound interest: Interest is earned on both the
principal and accumulated interest of prior periods.
Example : Suppose that you deposit TD 1000 in
your savings account that earns 5% annual interest.
How much will you have in your account after two
years using (a) simple interest and (b) compound
interest?
 Simple Interest
Interest earned = 5% of TD 1000 = .05×1000 = TD50 per year
Total interest earned = TD50×2 = TD100

Balance in your savings account:

= Principal + accumulated interest
= 1000 + 100 = TD 1100
Compound interest
Interest earned in Year 1 = 5% of TD 1000 = TD50
Interest earned in Year 2 = 5% of (100 + accumulated interest)
= 5% of (TD1000 + 50) = .05×1050 = TD 52,5

Balance in your savings account:

= Principal + interest earned

= TD1000 + TD50 + TD52,5 = TD 1102,5

There are two technique for adjusting time value of money.
They are:
1- Compounding technique / Future value techniques
2- Discounting / Present value Techniques

There are value of money at a future date with a given interest

rate is called future value. Similarly, the worth of money today
that is receivable or payable at a future date is called Present
Value
Future Value = Initial Value ( P) +
Accumulated Interest
PV = P + rxP
Initial value + Accumulated Interest
A generalized procedure for calculating the future value of a
single amount compounded annually is as follows:

FVn = CF ( 1+r) n
In this equation ( 1+r) n is called the future value interest factor ( FVIF)
Where

FVn = Future value of the initial flow n year hence

CF = Initial cash flow
r= Annual interest rate
n= number of years
Year Cash Flow Years to end n Future Value
0 0 3 0
1 C 2 C(1+r)2
2 C 1 C(1+r)1
3 C 0 C(1+r)0

FV3 = C [(1+r)2 +(1+r)1+1]

FVn = C [(1+r)n +(1+r)n-1 + …………+1]

Future Value Factor
Interest can be compounded monthly, quarterly and half-yearly.
If compounding is quarterly ; annual interest rate is divided by 4
and the number of years is multiplied by 4. Similarly, If
compounding is monthly ; annual interest rate is divided by 12
and the number of years is multiplied by 12
In general with m the number of times compounding par year ;
the formula to calculate the compound value is :

𝒓 𝒎𝒎𝒎
FV n = 𝑷𝑷 𝟏 +
𝒎
 When a future payment or series of
payments are discounted at the given rate
of interest up to the present date to reflect
the time value of money, the resulting
value is called present value.
 A generalized procedure for
calculating the present value of a
single amount compounded
annually is as follows:
PVn = FV / (1+r)n
. A cash flow stream is a finite set of payments that an investor will

receive or invest over time.

. The PV of the cash flow stream is equal to the sum of the present
value of each of the individual cash flows in the stream.

. The PV of a cash flow stream can also be found by taking the FV of

the cash flow stream and discounting the lump sum at the appropriate
discount rate for the appropriate number of periods
FV4 = CF4/(1+r)4 + CF3 /(1+r)3 + CF2 /(1+r)2 +CF1 /(1+r)

FVn = C /(1+r)n + C /(1+r)n-1 + ……+ C /(1+r)

 AnnuityDue = Annuity Ordinary x (1 + i)
The difference between the ordinary annuity
and the annuity due is one compounding
period
Each payment of an ordinary annuity belongs
to the payment period preceding its date,
while the payment of an annuity-due refers to
a payment period following its date
Example
You Plan to attend a French engineering school and
you have to take out € 50 000 in a loan at 12%.
You want to figure out your yearly payment ; given you
will have 5 years to pay back the loan

0 1 2 3 4 5

50000 ? ? ? ? ?
 Principal
Year Begening Balance Yearly payment Interest
Repayment

1 50,000TD 13,870TD 6,000TD 7,870TD

2 42,130TD 13,870TD 5,056TD 8,815TD

3 33,315TD 13,870TD 3,998TD 9,873TD

4 23,442TD 13,870TD 2,813TD 11,057TD

5 12,384TD 13,870TD 1,486TD 12,384TD

 Remuneration for lender
Cost for borrower
the interest rate depends on:
consumer Impatience
Investment Opportunities
 Interest rate and investment
interest Rate VAN

Business investment

Demand for loanable funds

Rate used for future cash flow compounding

expected return on the market for an

investment with comparable risk and project
time life
 Taxe
Gross rate Net rate

Inflation
Nominal rate Real rate
 Lender
If interest income are taxed :
Gross rate ≠ Net rate

Borrower
If Interest expenses are deductible:
Gross rate ≠ Net rate

r net = r gross ( 1- τ )
• Nominal rate :expressed in monetary unit

• Real rate: expressed in good unit

1+ r nom = (1+ r real ) * (1+Π )

Low inflation: r nom = r real + Π

 1+r2
1 year
0 1 2

rn equivalent rate period of n years

Rates are called r r

r annual rate
equivalent if 1+r (1+r)2
1+r2 = ( 1+ r )2 r2 = ( 1+ r )2 -1
they
provide the 6 months
1+r

same FV after 0
r1/2
0,5
r1/2
1

the same
1+r1/2 (1+r1/2)2
period of 1+r = (1+r1/2)2 r1/2 = (1+r) 1/2 -1
investment rn = (1+r) n -1 r= (1+rn) 1/n -1
Rate calculated with simple interest over 1 year
Not compatible with compounding
Rate by period = APR/k
k number of period per year

The proportional rate should not be used to

discount We use AER
The annual percentage rate (APR) indicates the
amount of interest paid or earned in one year without
compounding. APR is also known as the nominal or
stated interest rate. This is the rate required by law.
We cannot compare two loans based on APR if they
do not have the same compounding period.
To make them comparable, we calculate their
equivalent rate using an annual compounding period.
We do this by calculating the effective annual rate
(EAR) .
APR is the quoted annual rate with a pre-specified
compounding frequency. [Let m be the number of
compounding periods per year for this APR.]
EAR is the effective annual rate at an annual
compounding frequency. [One compounding per year]
The two should generate the same amount of money
in one year:
(1+APR/m)m=(1+EAR)  EAR=(1+APR/m)m-1.
EAR = (1+APR/k) k -1
Calculating an EAR or Effective Annual Rate

Assume that you just received your first credit card statement
and the APR, or annual percentage rate listed on the statement, is
21.7%. When you look closer you notice that the interest is
compounded daily. What is the EAR, or effective annual rate, on
your credit card?

What is the EAR on a quoted or stated rate of 13% that is

compounded monthly?
Verify the answers: 24.23%; 13.80%.
Future Value of Annuity
Present value of annuity
Present Value of growing annuity
Future Value of growing annuity
 Perpetuity
PV = P/r

Growing perpetuity
PV = P/ (r-g)