PROJECT EVALUATION

GRADED ASSIGNMENT – ANSWER WITH EXPLANATION.

IMT GHAZIABAD PG PROGRAM

QUESTION 1

NPV

Calculate the NPV of the project. Assume that the cash flows occur at the end of each year.

a) $34.04 million
b) $89.20 million
c) $11.11 million
d) $24.35 million

✓ Correct

c) $11.11 million

Feedback:

Since the cash flows occur from year 1, all the cash flows need to be discounted. The NPV of
the project can be calculated using the formula: =NPV(RATE, Range of values). Using the
NPV function in Excel, you will get: $11.11 million
 QUESTION 2

Sensitivity Analysis

The brand manager has been given a target of achieving a cash inflow of $3 million in Year
2. If he fails to do so, the project will be discontinued. This is the worst-case scenario for the
manager.

The manager estimates the worst-case analysis with the help of the cash inflows provided in
the following table.

Year 1 2 3 4 5
Cash Outflow ($ million) 10 8 0 0 0
Cash Inflow (₹ lakh) 2 2 0 0 0

What would be the NPV of the project in case the brand is discontinued after two years, i.e.,
the cash inflow and outflow is 0 for the rest of the three years?

$-12.55 million

✓ Correct

Feedback:

Since the cash flow for the 2nd year is $2 million, which is less than $3 million, the company
will stop the project after 2 years. Therefore, the NPV is calculated considering the cash
flows of the period of two years.

The NPV of the project can be calculated using the formula: =NPV(RATE, Range of values).
Using the NPV function in Excel, you will get: $-12.55 million.
 QUESTION 3

Risk-Adjusted NPV

The brand manager also presents a third scenario, where due to a new entrant in the market,
the company has to spend more on marketing activities. Hence, it would require a larger
marketing budget. Here, the brand manager assumes that the cash inflows remain the same as
per the regular scenario; however, the cash outflows would be revised as given in the
following table.

Year 1 2 3 4 5
Cash Outflow ($ million) 10 10 8 5 5
Cash Inflow ($ million) 3 5 10 12 15

The following probabilities are assigned to each scenario:

• Regular launch and success (best case): 60%

• Failure in year 2 (worst case): 20%
• Success following a larger expenditure on marketing due to a new entrant (base case):
20%

Calculate the risk-adjusted NPV for the project. (You can use the NPVs of the first two
scenarios as calculated in the previous questions.) Choose the closest option.

$4.71 million

✓ Correct
Feedback:

The risk-adjusted NPV is calculated by multiplying the NPVs of different scenarios by their
respective probabilities.

The NPV for the three scenarios and their probability are provided in the table given below.

NPV (₹ lakh) Probability

Best case 11.11 60%
Worst case -12.55 20%
Base case 2.77 20%

Using the formula for calculating the risk-adjusted NPV, we get: (11.11 * 0.60) -(12.55 *
0.20) + (2.77 * 0.20) = $4.71 million