Lecture-2

Recap of Previous Lecture

Investment appraisal : Basic Techniques (Pay back period and accounting rate of return)

Pay back period :Equal and Unequal

ARR=PBT/Initial investment or average investment

Bail out pay back period

Advance Techniques : Discounted pay back period

: Net Present value

Net present value of cash flows less Present value of investment

+ Accept /Negative Reject

0 1 2 3 4 5

-90,000 40,000 30,000 20,000 20,000 20,000

Discount Rate =10%

Present value of cash flows

Discount factor

1 .909 .826 .751 .683 .620

Present Value

-90,000 36,360 24,780 15,020 13,660 12,400

NPV=12,261 Positive Accept the project

What if NPV =0 Accept

Examining Point of View =

1) Determine Cash flows on the basis of information

2) Discounting

Objective of today How to Handle Discounting

Three Types of Discounting

1-Single Sum Discounting = Har cash flow ko individual discount factor sai multiply kia

2-Annuity Discount

Three Features of Annuity

a) Equal Cash flows

b) Occur in regular intervals
c) For definite/define period

Kinds

Simple Annuity :

0 1 2 3 4 5

1000 1000 1000 1000 1000

10% Discount factor

Annuity Factor/Formula = PV= R{1-(1+i)-n}

I
N=5

Advance Annuity
0 1 2 3 4 5

1000 1000 1000 1000 1000 -

N=4
 Delayed Annuity

0 1 2 3 4 5 6 7

1000 1000 1000 1000 1000

1 st method : 5 ka annuity factor nikal dain year 2 pai ajaegha phir 2 saalo ka discount laga k 0
pai lai kajaen

2nd Method : 7 saalo k annuity factor lain , 2 saalo ka discount factor minus kr dain…

3-Perpetuity Discounting

Three Features of perpetuity

a) Equal Cash flows

b) Occur in regular intervals
c) For indefinite period

Normal Perpuity (Formula)

PV=R/I (How this formula derived )

1000/.10=10,000

Advance Perpuity

Ans 11,000 (Take Time line of annuity)

Delayed

Practice Questions

1 Cash flows 3000 Year 3 to 15 Discount rate 15 % Calculate Present Value ? Ans 12,622

2 Cash Flows 5000 Year 1 to 10 Discount 12 % Ans 28,250

3 Cash flows 6000 From year 5 onwards 25 % Ans 9,830

4 Cash flows 11000 From 0 onwards 15 % Ans 84,333

Practice Question

0 1 2 3 4 5 6 7 8 9 10 11

- - 5000 - 7000 7000 7000 7000 7000 - -

2000(onwards)

Discount Rate 10 %

Answer 31,799 or 31,786 (More or less same)

How to determine cash flows

Cost 120,000 Residual value =20,000 Life 4 Years Sales year 1 =7000 Units 500 units decrease
every year

Sales price per Unit =15 variable cost =Rs 8 Relevant Fixed Costs=5000 Per year Discounting
Factor =12 %.

Calculate NPV.

Things we would incorporate step by step in NPV

a) Inflation b) Working Capital c) Taxation d)How to determine Relevant Cash Flows

Half year discount interest rate /2

Quartelry Interest rate /4