ASSIGNMENT SHEET

Problem No.1
A Cosmetics company is considering an investment in a new beauty preparation for which the following
information is available.

1. Investment in new machinery required for manufacture will cost Rs.1,50,000

2. A part of the present machinery that is lying idle for the last two years is also to be used for
manufacturing the new product.
(A) The machinery was purchased five years ago for Rs.75,000 and its depreciated value today is Rs.37,500
(B) It can be used at least another five years with normal maintenance and can be sold at Rs.5000 after five
years.
3. Increase in working capital on account of new product will be as under:
a. Increase in sundry debtors Rs.75,000
b. Increase in inventories Rs.1.00.000
c. Increase in Current liabilities Rs.1,00,000
4. Sales revenues for new product is estimated at Rs.7,50,000 per year.
5. Manufacturing cost (Including allocation of Rs.30,000) fixed cost from service departments) is
estimated to be Rs.3,40,000 per year.
6. Selling & Administrative expenses directly associated with the product are Rs.3,00,000 Per year
7. The new machinery will have trouble free services for eight years but require overhauling in the fourth
year costing Rs.10,000. its estimated resale value at the end of five years will be Rs.20,000
8. Introduction of new product will slightly affect the production schedules of existing products
resulting in a loss pf profit contribution on other products to an extent of Rs.25,000 per year
9. Bad debts to be written off on account of new product are Rs.10,000 p.a
10. Step up promotional expenses in 3rd year are Rs.70,000
11. All new investment and additional working capital requirements would be financed by raising
term loan to be repaid in four years in equal installments interest on term loans @ 15.0%p.a. works
out as Rs.29,500.00, Rs.21,000.00, Rs.12,500.00, and Rs.4,500.00 respectively for the first, second,
third, and Fourth years.
12. Depreciation being charged on Straight the basis @10.0%p.a. is also acceptable for income tax
purpose.
13. Rate of Income Tax 40%
14. Expected project life is 5 years.
Compute the project cash flows from the long term funds point of view.

Problem No. 2
AC Corporation is considering the risk characteristics of a certain project. The firm has identified that the
following factors, with their respective expected values, have a bearing on the NPV of this project.
Investment 5400
Sales 16000
Variable costs 13000
Fixed costs 2000
Depreciation 450
Pretax profit 550
Taxes @ 40% 220
PAT 330
Operating cash flows 780
NCF 780

Assume that the following underlying variables can take the values as shown below:

Variable Pessimistic Optimistic

Investments 6200 5000
Sales 14000 18000
Variable Cost (% of sales) 83% 80%
Fixed costs 2100 1900

Calculate the sensitivity of NPV to variation in

 (a) Investments
(b) Sales
(c) Variable cost % of sales.
(d) Fixed costs

Problem No. 3
An infrastructure company is considering a proposal to set up a new project at a cost of
Rs.500 crores. The proposed project has life of 5 years with no salvage value. The Year EBDT
estimated EBDT from this proposed project are as follows: 1 100
The tax rate is 40%. Assume the company uses SLM depreciation and same for tax 2 110
purpose. The cost of capital will be 10%. Calculate NPV and PI and suggest accepting or 3 130
rejecting the project. 4 150
5 200
Problem No. 4
Zigma Industries has to decide whether to set up a large, medium or a small plant for its new range of
refrigerators. A large plant will cost the company Rs.25 lakhs, whereas a medium plant will cost Rs.18 lakhs
and a small plant will cost Rs.12 lakhs to the company. An extensive market survey and a cost profit volume
analysis carried out by the company reveal the following outcomes:
High demand probability = 0.50
Moderate demand probability = 0.30
Low demand probability = 0.20
a. A large plant with high demand will yield an annual profit of Rs.100 lakhs.
b. A large plant with moderate demand will yield an annual profit of Rs.60 lakhs.
c. A large plant with low demand will lose Rs.20 lakhs annually because of production inefficiencies.
d. A medium plant with high demand will yield an annual profit of Rs.75 lakhs.
e. A medium plant with moderate demand will yield an annual profit of Rs.45 lakhs.
f. A medium plant with low demand will lose Rs.25 lakhs annually because of production inefficiencies.
g. A small plant with high demand would yield Rs.25 lakhs annually, taking into account the cost of lost
sales due to inability to meet demand.
h. A small plant with moderate demand will yield Rs.35 lakhs, as the losses due to lost sales will be
lower.
i. A small plant with low demand will yield Rs.45 lakhs annually, as the plant capacity and demand will
match.
Draw a decision tree and find the optimum solution.

Problem No. 5
The R&D division of a pharmaceutical firm based at Pune has invented a molecule for curing type-II diabetes. It
has three options- to manufacture the drug, to sell the formulation to another company or to conduct a market
study before taking any action. If it decides to manufacture the drug outright, then the drug has a 65% chance of
success with a profit of Rs.1.1 million, whereas its failure will result in a loss of Rs.0.25 million. If the company
conducts a market study, then there is a 75% chance that the study will give a positive report which will be
favourable to launch the drug. After the positive report of the study, if the company manufactures the drug, then
there are 70% chances that the drug will be a success, leading to a profit of Rs.1.2 million, whereas, a failure
will result in a loss of Rs.0.35 million. After the negative report of the study, if the company manufactures the
drug, then there are 20% chances that the drug will be success, leading to a profit of Rs.1.2 million, whereas a
failure will result in loss of Rs.0.35 million. A competitor firm is willing to pay Rs.0.5 million if the company
sells the formulation before the market study, Rs.0.65 million, if the market study results are positive and
Rs.0.45 million, if the market survey results are negative. What course of action should the company follows?
Give your advice using the decision tree analysis.

Problem No. 6
Consider the data in table for a small project. The actual performance is measure at the end of 5 months in terms
of % actual completion and actual cost incurred. Assume all activities will begin at the earliest, determine the
following:
(a) Cost performance index and schedule performance index.
(b) Revised project duration and cost (COC and TOC)
Activity Predecessor/s Normal time Normal cost Actual cost % actual
completion
A -- 4 6 6 100
B -- 12 15 6 40
 C -- 4 3 3 95
D A 10 15 2 7
E C 6 10 0 0
F A 14 11 8 7
G B,D,E 8 10 0 0

Problem No. 7
A Company is planning to buy a new machine and has received two competitive offers, both the machines have
same manufacturing capacity but differ in their initial price of the marginal cost of capital for the company is
12.0% recommend which machine to be purchased?
Machine Initial Estimated Operating & Maintenance Costs
Life Cost Y1 Y2 Y3 Y4 Y5 Y6 Y7 Y8 Y9 Y10
Offer A 6 Years 500 80 100 120 150 150 150
Offer B 10 Years 700 90 120 150 150 150 150 175 175 175 175

Problem No. 8
The progress observed at the end of the 7 th day from the beginning of the project is as given in the following
table:

Activity Estimated Budgeted cost of Actual cost (Rs. % of completion at

duration in days activity lakhs) end of 7 days
A 1-2 3 5 4 100
B 2-3 4 8 9 90
C 2-4 3 4 5 95
D 2-5 8 5 3 60
E 3-6 5 3 0 0
F 4-6 4 2 1 30
G 5-7 5 10 0 0
H 6-7 3 7 0 0

If the cost is incurred linearly in proportion to activity completion find out the:
1. Cost Variance
2. CPI
3. SPI
4. Estimated cost of the project completion
5. Estimated duration of the project.

Problem No. 9
A company with a 10% cost of funds and limited investment of Rs.160Lakhs is evaluating the desirability of
several investment proposals:
Project Initial Investment Life (Years) Annual Cash in Flow
(Rs.Lakhs) (Rs.Lakhs)
P 120 5 30
Q 80 3 32
R 80 4 25
S 40 7 8
T 120 9 15
i) Rank the projects according to profitability index and NPV methods.
ii) Determine optimal investment package.

Problem No. 10
The project consists of five tasks and is scheduled to take 13 weeks to complete. The actual status of the project
at the end of week 9 is given in the following table:
Task Duration Start End Budget Actual % Complete
(Weeks) Week Week current cost
A 3 1 3 300 350 100
 B 2 1 2 250 225 100
C 4 4 7 450 475 100
D 7 3 9 600 300 75
E 6 8 13 500 300 75
Calculate:
1. Cost variance
2. Schedule variance
3. CPI
4. SPI
5. Cost of completion
6. Time of completion
According to you project is as per the schedule and within the budget?

Problem No. 11
A company is considering a new project for which initial investment is estimated as under
Project cost estimation in Rs. Lacs
Land 35.0  Rs.30 lacs is for total 20000 sqm of land acquired.
However, the project needs only 8000 sq.m.
 Rs.5 Lacs is for development of land for the project.

Building 150.0
Plant and Machinery 350.0  This includes Rs.30 lacs book value of machinery being
transferred from the existing factory.
Hint: This is sunk cost
Margin for working capital 70.0
Other fixed assets 70.0
The projections for the operating results for a ten year period are as per the following table:
1 2 3 4 5 6 7 8 9 10
Sales 1010 1430 1600 1790 2000 2220 2470 2635 2800 3000
Cost of 915 1245 1360 1515 1685 1845 2045 2185 2340 2500
production
Interest on 40 57 63 70 80 85 95 105 110 120
working
capital
Interest on 65 60 55 40 35 20 10 5 0 0
term loan
Depreciation 50 50 50 50 50 50 50 50 50 50
Salvage value of fixed assets at the end of 10 year is estimated at Rs.76 lacs. The rate of income tax is 52% and
WACC is 15%.
Work out the project cash flows for evaluation from ‘Long term funds’ point of view and find out if the project
has a positive NPV.

Problem No. 12
An oil company has recently acquired rights in a certain area to conduct survey and test drilling to lead to lifting
oil if it is found in commercially exploitable quantities.
The area is considered to have good potential for finding oil in commercial quantities. At the outset, the
company has the choice to conduct further geological tests or to carry out a drilling programme immediately. On
the known conditions, the company estimates that there are 70:30 chances of further tests showing a ‘success’.
Whether the tests show the possibility of ultimate success or not or even if no tests are undertaken at all, the
company could still pursue its drilling programme or alternatively consider selling its right to drill in the area.
Thereafter, however, if it carries out the drilling programme, the likelihood of final success or failure is
considered dependent on the foregoing stage. Thus:
 If successful tests have been carried out, the expectation of success in drilling is given as 80:20.
  If the tests indicate failure, then the expectations of success in drilling is given as 20:80.
 If no tests have been carried out at all, the expectation of success in drilling is given as 55:45.
Costs and revenues have been estimated for all possible outcomes and the NPV of each is as follows:
Outcome NPV (Rs. Million)
Success:
With prior tests 100
Without prior test 120
Failure:
With prior tests -50
Without prior test -40
Sale of exploitation rights:
Prior tests shows success 65
Prior test shows failure 15
Without prior tests 45
Draw the decision tree and recommend the appropriate selection.