STRATEGIC FINANCIAL MANAGEMENT

BATCH 2019-21 | ACADEMIC YEAR 2020-21 | SEM III

ASSIGNMENT-10 MARKS
CASE-STUDY: Investment Decisions Under Risk & Uncertainty

You are hereby instructed to build a financial model for investment decisions under risk and uncertainty of the
attached case-study. The assignment is an individual assignment and carries 20 marks.

Objective of the assignment:

This assignment aims to equip students to identify relevant cash flows, apply various tools of risk measurement,
analyse and forecast cash flow for investment decision under certain, risky and uncertain situations. The assignment
will enable students to understand advance excel functions and develop a financial model on Ms. Excel which can be
used for any given case of investment decision.

Instructions:
·         All the cells should be appropriately linked so that change in any one cell will reflect the change in subsequent
calculation. The model should be robust.
·         Explicitly state all the assumptions taken to build the model. Make sure the assumptions taken are valid and
rational. If possible back your assumptions with report/ data/ statistics.
·         Answer all the questions (a to g) of the attached case-study in the template worksheet.
·         The steps to use 'Data Table' function of Ms Excel for sensitivity analysis is mentioned in the 'data table-tutorial'
worksheet.
·         The assignment needs to be solved on Microsoft Excel (i.e (.xlsx file tye) and the same file has to be upload on
the LMS. The name of the excel file should be 'roll no-first name' only. E.g 'PF1921-D01 Kautuk'. Please mention your
name, roll no, division and batch in the cell AE3 to AE7 of 'Template' worksheet of excel .
·         The 'scenario manager' and 'goal seek' function of excel are already been taught in the lectures.
·         The last day to submit the assignment is Thursday, 10th September 2020.

Learning Outcomes (CO2, CO3): After the completion of the assignment, students will be able to,
·         Estimate project's “relevant” cash flows and analyse them under certain, risky and uncertain situations.
·         Apply the conventional, statistical and modern risk analysis/capital budgeting techniques to the estimated cash
flows for taking investment decisions
·         Calculate the major capital budgeting techniques; payback period, discounted payback period, NPV, PI, IRR,
Expected NPV, Standard Deviation, Coefficient of Variation, break even point etc.
·         Evaluate the various approaches to analyse the risk of a project and take an investment decision
·         Construct a robust financial model to help take sound investment decisions under certain, risky and uncertain
environment
·         Use the above model to take an informed and sound investment decisions under certain, risky and uncertain
environment
 STRATEGIC FINANCIAL MANAGEMENT
BATCH 2019-21 | ACADEMIC YEAR 2020-21 | SEM III
ASSIGNMENT-10 MARKS
CASE-STUDY : Investment Decisions Under Risk & Uncertainty
(GPC) Guyton Products Company

(GPC) Guyton Products Company is a high-tech "lab-bench-to-market" development company that takes cutting-edge
reseach advances and translates them into consumer products. GPC has recently licensed a nano-fabrication coating
technology from a university that promises to significantly increase the efficiency with which solar energy can be harvested
and stored as heat.

GPC is considering using this technology in its existing product line. In the "Project S" for "solid", the technology would be
used to coat rock and concrete structures to be used as passive heat sinks and sources of energy-efficient residential and
commercial buildings.

The cost of required equipment to manufacture the solid coaters in Project S is Rs 8,750. The solid coaters would sell for
Rs2.5 per unit, and GPC believes that after Year 1, the sales price will decrease at the rate of 5% every year. The firm
believes it could sell 10,000 units every year. The variable costs would amount to Rs1.64 per unit and after Year 1, the
variable costs will increase at the inflation rate of 6%. The company’s non-variable costs would be Rs 1815 at Year 1 and
would increase at 4%. The project S would require net working capital at the beginning of each year in an amount equal to
5% of the year's projected sales; for example, NWC0 = 5%(Sales1). The projects would have a life of 4 years. The estimated
market value of the equipment at the end of the project’s 4-year life is Rs 433

If the project is undertaken, it must be continued for the entire 4 years. Also, the project's returns is expected to be highly
correlated with returns on the firm's other assets. The equipments would be depreciated over a 4-year period, using
depreciation rates 33.33%, 44.45%, 14.81% and 7.41% for all the 4 years respectively. The tax rate is 40%. Its cost of
capital is 10% for average-risk projects, defined as projects with a coefficient of variation of NPV between 0.8 and 1.2.

a. Develop a spreadsheet model, and estimate the net cash flows for each year. Based on these cash flows, find the project’s
NPV, Profitability Index, IRR, payback and discounted payback period. Do these indicators suggest the project should be
undertaken?

b. Now conduct a sensitivity analysis to determine the sensitivity of NPV to changes in the equipment cost, sales price,
number of units sold, variable costs per unit, non variable cost and WACC individually. Set these variables’ values at 30%
above and below their base-case values. Include a bar graph in your analysis to understand the variable that has the highest
impact on NPV. (Perform the sensitivity analysis using 'Data Table' tool in excel)
c. Now conduct an NPV break-even analysis by finding out level of an input that produces an NPV of exactly zero. (Inputs
being sales price per unit, variable cost per unit, non variable cost, number of units sold and WACC individually. (NPV break-
even analysis can be prformed using 'Goal Seek' tool of excel)

d. Now conduct a scenario analysis.

>> Assume that there is a 25% probability each of best-case condition and worst-case conditions, and a 50% probability of
base-case conditions.
>> The number of units sold in year 1 would change by 15%, variable cost per unit by 9%, non variable cost by 10%, tax rate
by 25%, sales price by 17% in best and worst case scenarios respectively.
>> % change annually after 1 year, for Project S
*units sold in worst case scenario would be -5% & in best scenario would be 5% as against 0% in base case.
*variable would increase with inflation rate of 6% in all scenarios.
*sales price will decrease by 5% in all scenarios.
e. If the project appears to be more or less risky than an average project, find its risk-adjusted NPV. Low-risk projects are
evaluated with a rate of 8%, and high-risk projects at 13%.
f. On the basis of information in the problem, would you recommend that the project be accepted?
g. State all the assumptions very clearly
 Analysis of an Expansion Project: Inputs and Key Results (Rupees in Lakhs) Analysis of a New (Expansion) Project: Cash Flows and Performance Measures Analysis of a New (Expansion) Project: Cash Flows and Performance Measures Analysis of a New (Expansion) Project: Cash Flows and Performance Measures
Part 1. Inputs and Key Results (Rupees in
Scenario: Lakhs)
Base-Case (RupeesWorst-Case
Scenario: in Lakhs) (Rupees in
Scenario: Lakhs)
Best-Case
Part 2. Cash Flows and Performance Measures Part 2. Cash Flows and Performance Measures Part 2. Cash Flows and Performance Measures Name of the Student Harshal Vaidya
Scenarios for Analysis Intermediate Calculations 0 1 2 3 4 Intermediate Calculations 0 1 2 3 4 Intermediate Calculations 0 1 2 3 4 Roll No. Of the Student 66
Scenario Name Base-Case Base-Case Worst Best Unit sales 10,000.00 10,000.00 10,000.00 10,000.00 Unit sales 8,500.00 8,075.00 7,671.25 7,287.69 Unit sales 11,500.00 ### ### ### Division B
Probability of Scenario 50% 25% 25% Sales price per unit 2.50 2.38 2.26 2.14 Sales price per unit 2.08 1.97 1.87 1.78 Sales price per unit 2.93 2.78 2.64 2.51 Batch MMS
Inputs: Variable cost per unit (excl. depr.) 1.64 1.74 1.84 1.95 Variable cost per unit (excl. depr.) 1.79 1.89 2.01 2.13 Variable cost per unit (excl. depr.) 1.49 1.58 1.68 1.78 Academic Year 2019-21
Equipment cost 8750 8750 8750 8750 Nonvariable costs (excl. depr.) 1,815.00 1,887.60 1,963.10 2,041.63 Nonvariable costs (excl. depr.) 1,996.50 2,076.36 2,159.41 2,245.79 Nonvariable costs (excl. depr.) 1,633.50 1,698.84 1,766.79 1,837.47
Project cost of capital (r) 10.00% 10.00% 10.00% 10.00% Sales revenues = Units × Price/unit 25,000.00 23,750.00 22,562.50 21,434.38 Sales revenues = Units × Price/unit 17,637.50 15,917.84 14,365.85 12,965.18 Sales revenues = Units × Price/unit 33,637.50 ### ### ###
Tax rate 40% 40.00% 50.00% 30.00% NOWCt = 15%(Revenuest+1) 1,250.00 1,187.50 1,128.13 1,071.72 NOWCt = 15%(Revenuest+1) 881.88 795.89 718.29 648.26 NOWCt = 15%(Revenuest+1) 1,681.88 1,677.67 1,673.48 1,669.29
Salvage value, equipment, Year 4 433 433 433 433 Basis for depreciation Basis for depreciation Basis for depreciation
Units sold, Year 1 10000 10000 8500 11500 Annual depreciation rate (MACRS) 33.33% 44.45% 14.81% 7.41% Annual depreciation rate (MACRS) 33.33% 44.45% 14.81% 7.41% Annual depreciation rate (MACRS) 33.33% 44.45% 14.81% 7.41%
Annual change in units sold, after Year 1 0.00% 0.00% -5.00% 5.00% Annual depreciation expense 2,916.38 3,889.38 1,295.88 648.38 Annual depreciation expense 2,916.38 3,889.38 1,295.88 648.38 Annual depreciation expense 2,916.38 3,889.38 1,295.88 648.38
Sales price per unit, Year 1 2.5 2.5 2.075 2.925 Remaining undepreciated value 8,750.00 5,833.63 1,944.25 648.38 - Remaining undepreciated value 8,750.00 5,833.63 1,944.25 648.38 - Remaining undepreciated value 8,750.00 5,833.63 1,944.25 648.38 -
Annual change in sales price, after Year 1 -5.00% -5.00% -5.00% -5.00%
Variable cost per unit (VC), Year 1 1.64 1.64 1.7876 1.4924
Annual change in VC, after Year 1 6.00% 6.00% 6.00% 6.00%
Nonvariable cost (Non-VC), Year 1 1815 1815 1996.5 1633.5 Cash Flow Forecast Cash Flows at End of Year Cash Flow Forecast Cash Flows at End of Year Cash Flow Forecast Cash Flows at End of Year
Annual change in Non-VC, after Year 1 4.00% 4.00% 4.00% 4.00% 0 1 2 3 4 0 1 2 3 4 0 1 2 3 4
Working capital as % of next year's sales 5.00% 5.00% 5.00% 5.00% Sales revenues = Units × Price/unit 25,000.00 23,750.00 22,562.50 21,434.38 Sales revenues = Units × Price/unit 17,637.50 15,917.84 14,365.85 12,965.18 Sales revenues = Units × Price/unit 33,637.50 ### ### ###
Variable costs = Units × Cost/unit 16,400.00 17,384.00 18,427.04 19,532.66 Variable costs = Units × Cost/unit 15,194.60 15,300.96 15,408.07 15,515.93 Variable costs = Units × Cost/unit 17,162.60 ### ### ###
Key Results: Project Evaluation Measures Nonvariable costs (excluding depreciation) 1,815.00 1,887.60 1,963.10 2,041.63 Nonvariable costs (excluding depreciation) 1,996.50 2,076.36 2,159.41 2,245.79 Nonvariable costs (excluding depreciation) 1,633.50 1,698.84 1,766.79 1,837.47
Base-Case Base-Case Worst Best Depreciation 2,916.38 3,889.38 1,295.88 648.38 Depreciation 2,916.38 3,889.38 1,295.88 648.38 Depreciation 2,916.38 3,889.38 1,295.88 648.38
Probabilities 50% 25% 25% Earnings before interest and taxes (EBIT) 3,868.63 589.03 876.48 -788.29 Earnings before interest and taxes (EBIT) ### ### ### -5,444.91 Earnings before interest and taxes (EBIT) ### ### ### 7,237.08
NPV 598.71 598.71 -15,328.21 19,194.30 Taxes on operating profit (40% rate) 1,547.45 235.61 350.59 - Taxes on operating profit (50% rate) Taxes on operating profit (30% rate) 3,577.51 ### ### 2,171.12
IRR 0.14 0.14 NA 0.90 Net operating profit after taxes (PAT) 2,321.18 353.42 525.89 -788.29 Net operating profit after taxes (PAT) -2,469.98 -5,348.85 -4,497.50 -5,444.91 Net operating profit after taxes (PAT) 8,347.52 6,204.25 6,402.45 5,065.95
PI 1.06 1.06 -0.59 2.84
Payback 2.21 2.21 NA 0.93 Add back depreciation 2,916.38 3,889.38 1,295.88 648.38 Add back depreciation 2,916.38 3,889.38 1,295.88 648.38 Add back depreciation 2,916.38 3,889.38 1,295.88 648.38
Discounted payback 3.26 3.26 NA 1.02 Equipment purchases -8,750.00 Equipment purchases -8,750.00 Equipment purchases -8,750.00
Expected NPV for Scenario Analysis 1,265.88 299.36 -3,832.05 4,798.57 Salvage value 433.00 Salvage value 433.00 Salvage value 433.00
Tax saving on salvage value (40% rate) -173.20 Tax saving on salvage value (50% rate) -216.50 Tax saving on salvage value (30% rate) -129.90
Cash flow due to change in WC -1,250.00 62.50 59.38 56.41 1,071.72 Cash flow due to change in WC -881.88 85.98 77.60 70.03 648.26 Cash flow due to change in WC -1,681.88 4.20 4.19 4.18 1,669.29
Risk Adjusted NPV using Coefficient of Variation Project net cash flows -10,000.00 5,300.05 4,302.17 1,878.17 1,191.60 Project net cash flows -9,631.88 532.38 -1,381.88 -3,131.60 -3,931.77 Project net cash flows -10,431.88 11,268.10 ### 7,702.51 7,686.72
Standard Deviation: Absolute Measure of Risk 12,223.77
Coefficient of Variation: Relative Measure of Risk
= Std Dev / Expected NPV = 9.66 Calculations for Payback 0 1 2 3 4 Calculations for Payback 0 1 2 3 4 Calculations for Payback 0 1 2 3 4
Given: CV range of firm's average-risk project: 0.8 to 1.2 Cumulative cash flows for payback -10,000.00 -4,699.95 -397.78 1,480.38 2,671.99 Cumulative cash flows for payback -9,631.88 -9,099.49 -10,481.37 -13,612.97 -17,544.74 Cumulative cash flows for payback -10,431.88 836.22 ### ### ###
Low-risk WACC = 8% Discounted cash flows for disc. payback -10,000.00 4,818.23 3,555.51 1,411.10 813.88 Discounted cash flows for disc. payback -9,631.88 483.98 -1,142.05 -2,352.81 -2,685.45 Discounted cash flows for disc. payback -10,431.88 10,243.72 8,345.31 5,787.01 5,250.13
WACC = 10% Cumulative discounted cash flows -10,000.00 -5,181.77 -1,626.26 -215.17 598.71 Cumulative discounted cash flows -9,631.88 -9,147.89 -10,289.94 -12,642.75 -15,328.21 Cumulative discounted cash flows -10,431.88 -188.15 8,157.16 ### ###
High-risk WACC = 13%
Risk-adjusted WACC = (decided based on calcuated CV) 13%
Risk adjusted NPV = 714.98

NPV Breakeven Analysis

Input Value
that
Produces
Input Zero NPV
Sales price per unit, Year 1 2.47
Variable cost per unit (VC), Year 1 1.67
Annual change in units sold, after Year 1 -0.06
Units sold, Year 1 9,437.35
Nonvariable cost (Non-VC), Year 1 2,073.40
Project r 0.14
Annual change in units sold, after Year 1 -0.06
Units sold, Year 1 9,437.35
Nonvariable cost (Non-VC), Year 1 2,073.40
Project r 0.14

Data Table for Sensitivity Analysis

Deviation Equipment NPV Deviation Variable NPV

from Base Cost 598.71 from Base Costs 598.71
-30% 6,125.00 -30% 1.15
0% 8,750.00 0% 1.64
30% 11,375.00 30% 2.13

Deviation Sales Price NPV Deviation Non Variable NPV

from Base / unit 598.71 from Base Costs 598.71
-30% 1.75 -30% 1,270.50
0% 2.50 0% 1,815.00
30% 3.25 30% 2,359.50

Deviation No. of Units NPV Deviation WACC NPV

from Base Sold 598.71 from Base 598.71
-30% 7,000.00 -30% 7%
0% 10,000.00 0% 10%
30% 13,000.00 30% 13%

Data for Sensitivity Graph

Deviation from Base
Factors −30% 0% 30% Range
Equipment Cost $2,403 $599 −$1,397 3,799.59
Sales Price PU −$19,610 $599 $14,014 33,623.13
No. of Units Sold −$3,140 $599 $3,791 6,930.65
Variable Costs $10,977 $599 −$14,475 25,452.04
Non Variable Costs $1,860 $599 −$663 2,523.24
WACC $1,153 $599 $92 1,061.18

Sensitivity Analysis Line Graph for Project S

$13,000

$10,000

$7,000

$4,000

$1,000
−30% 0% 30%
−$2,000

−$5,000

−$8,000

−$11,000

−$14,000

−$17,000

−$20,000

Equipment Cost Sales Price PU No. of Units Sold

Variable Costs Non Variable Costs WACC

Conclusions of the sensitivity analysis and Graph:

1. NPV of the project is most sensitive to changes in the Selling Price P U of the product.
2. NPV of the project is least sensitive to changes in the WACC.
3. WACC is the only element of the sensitive analysis, in which the NPV remains positive even with an increase of 30%

Assumptions for the Investment Decision

1. Depreciation has been calculated using the Modified Accelerated Cost Recovery System (MACRS), as per which
there would be no residual value at the end of the useful life of the asset. Thus, the Book value of the asset at the
end of year 4 comes to 0. Any amount received as salvage is treated as profit on sale of assets.

2. It is assumed that loss is not carried forward for tax purposes. Thus, loss in any year cannot be set off against
profits of the subsequent years. There will be no tax paid in case of loss, and there will be no reduction in taxable
profit of subsequent years, if any, on account of such loss from previous years.

3. Profit on sale of assets is not adjusted against operating/business losses, for the purpose of tax calculatins. Thus
any profits from from sale of assets is taxed at the required rate, even if there is operating loss in the same year.

Final Investment Decision:

1. On the basis of the information provided and calculations done above, I would recommend for the project to be
accepted, as it provides a positive NPV even at the higher-risk WACC of 13%.
2. It should be noted that the Co-efficient of Variation of the project is very high (>9). This is because the 2 alternate
scenarios viz. Best case and Worst case, have extremely high and negative NPV amounts respectively. The Base
case scenario has a positive NPV and has been assigned a probability of happening of 50%.
3. Based on all parameters viz. NPV, IRR, PI, Payback period and Discounted Payback Period, I would recommend
for the project to be selected.
X P Px x-x bar ^ 2 = E * prob X P Px
0 0.04 0 4.41 0.1764 598.71 0.5 299.355 -667.1675 445112.47306
1 0.22 0.22 1.21 0.2662 -15328.21 0.25 -3832.0525 -16594.088 275363740
2 0.46 0.92 0.01 0.0046 19194.3 0.25 4798.575 17928.4225 321428333.34
3 0.18 0.54 0.81 0.1458 1265.8775
4 0.08 0.32 3.61 0.2888
5 0.02 0.1 8.41 0.1682
2.1 1.05

1.0246951
222556.23653
68840934.989
80357083.335
149420574.56

12223.770881
Following is a tutorial for constructing a Data Table to be used in sensitivity analysis.

Instructions for Constructing Data Tables:

Step 1:

Deviation Sales NPV

from Base Price/unit Set up the Data Table by typing in the labels and numbers shown here. The
-30% column for sales price/unit is the input range and the column for NPV is the
0% ₹ 1.50 output range. Data Tables take each input value and then automatically
calculate a new output based on the input. Be sure to type in the actual sales
30% price of Rs1.50 and not a formula. Every year we have students who make this
mistake! Don't be one of them!
Step 2:

Deviation Sales NPV Enter the formula =$B$19*(1+A18) into the light green cell and then copy it
from Base Price/unit into the light blue cell. This sets up the input range's values of sales prices for
which you want new NPV's to be calculated. It is ok to have a formula in the
-30% ₹ 1.05 input range, but be sure that none of these inputs is a formula that refers back
0% ₹ 1.50 to the actual value of sales in the input section of the worksheet.
30% ₹ 1.95

Step 3:

Deviation Sales NPV Enter into the tan cell a formula that refers to the cell in the results section
from Base Price/unit #REF! which shows the NPV for the given set of inputs. In the template, that is =$B$25.
Notice that the tan cell will show the current value of NPV.
-30% $0.00
0% $1.50
30% $0.00

Deviation Sales NPV Now use your cursor to highlight the range we show in gray (this is called the
from Base Price/unit $0.00 Data Table range); notice that this highlighted range includes the cells for the
new inputs for price and the cell for the reference to NPV.
-30% $0.00
0% $1.50
30% $0.00

With the range still highlighted, open the Table dialog box. In Excel
2010, select Data, What-If-Analysis, then Data Table.

This next step is a bit tricky, so be careful. The cursor in the dialog box will be blinking in the "Row input cell:" box.
Here you have to tell Excel if the inputs in your Data Table are arranged in a row or a column. Excel assumes a row,
but this is not correct in our example--your inputs are in a column, Column B. So, you click on the "Column input
cell" box, causing the cursor to blink in that box.

Excel wants to know where the input variable, sales price, first enters the model. If you look up in the Input Data
section, you will see that it enters in cell B14, so you type B14 in the Column input cell (or click on cell B14 to enter
it). Here's the final, completed, dialog box:

When you click OK, Excel will calculate NPV at the three input values specified in your Data Table, insert them in
the table, leaving the Data Table as shown below.

Deviation Price NPV

from Base $0.00
-30% $0.00 -$13,359.64
0% $1.50 $956.29
30% $0.00 $15,272.21