www.Vidyarthiplus.

com 14-Jan-12

M.B.A. II Year – 2011‐12
Elective Subject

BA6036 - STRATEGIC INVESTMENT AND

FINANCING DECISIONS
Unit II

Prepared By S.Nagarajan / Professor / MBA 
1
/ Sudharsan Engineering College

UNIT II APPRAISAL TECHNIQUES

NPV, IRR, Profitability Index, Pay Back, ARR 

Significance of Information and Data Bank in Project  Reference‐8‐Page 9.7
Selections 
Mr.Karuppiah – 07‐01‐12
Investment Decisions Under Capital Constraints ‐ Miss.Reka – 07‐01‐12
Capital Rationing 
Portfolio – Portfolio Risk and Diversified Projects.  Miss Sathya – 18‐01‐12

1
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

TEXT BOOKS

1. Prasanna Chandra, Financial Management, 7th Edition, Tata McGraw Hill, 2008.
2. Prasanna Chandra, Projects : Planning, Analysis, Financing Implementation and Review,
10th Edition, Tata McGraw Hill, New Delhi, 2009.

REFERENCES

3. Bodie, Kane, Marcus : Investment, Tata McGraw Hill, New Delhi2002.

4. Brigham E. F & Houston J.F. Financial Management, Thomson Publications, 2003.
5. I. M.Pandey, Financial Management , Vikas Publishing House, 2003. – 10th Edition
6. M.Y.Khan and P.K.Jain, Financial Management Text and Problems, Tata McGraw Hill.
Publishing Co, 2003. – 5th Edition

Additional References
7. Security Analysis and Portfolio Management – Punithavathi Pandian
8
8. M.Y.Khan
M Y Khan and P.K.Jain,
P K Jain Financial Management Text and Problems,
Problems Tata McGraw Hill
Hill.
Publishing Co, 2003. – 6th Edition

Prepared By S.Nagarajan / Professor / MBS 
3
/ Sudharsan Engineering College

Time Value of Money

1. Rationale
2. Techniques:

(a)  Compounding Technique
(b)
(b)   Semi annual and other compounding periods
Semi annual and other compounding periods
(.c)  Future / Compounded value of Series of Payments
(d)  Compound sum of Annuity
(e) Present value or discount technique

Prepared By S.Nagarajan / Professor / MBS 
4
/ Sudharsan Engineering College

2
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

Evaluation of Investment Opportunities

Discounted Cash Flow methods

• Net Present value (PV)

( )
• Internal Rate of Return (IRR)
• Profitability Index [or] Benefit Cost Ratio (PI)

Non-Discounted Cash Flow Methods

• Payback (PB)
• Discounted Payback
• Accounting rate of return (ARR)

Prepared By S.Nagarajan / Professor / MBS 
5
/ Sudharsan Engineering College

A = P(1+r/m)^mn [Table A-1]

A=amount at the end of period
P=Principle at the beginning of the period
r = rate of interest
m = number of times per year compounding
n = number of years

Annuity:‐ Every period  normally at the beginning of every year,  same amount 
(say) “P” is paid with an annual interest of (say) “r”

A = P [(1+r)1  +  (1+r)1 +  (1+r)2 +  (1+r)3 +  (1+r)4 +………..+  (1+r)n

Compounded Value of Interest Factor Annuity  (CVIFA) [Reference 8 -Table A-2]
Reference 8 – Example 2.1
Assume Mr x places his saving of Rs 1000 in a two year time deposit of a bank which 
p g y p
yields 6% interest. What is the maturity value?

Reference 8 – Example 2.3
Mr x deposits Rs 2000 at the end of every year for 5 years in his savings account 
paying 5 %  compounded annually . What is  the maturity value?

Prepared By S.Nagarajan / Professor / MBS 
6
/ Sudharsan Engineering College

3
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

Present value / Discounted  technique     P = A / (1+i)^n
A=amount at the end of period
P=Principle at the beginning of the period
I = rate of interest
n = number of years
Present Value of Interest Factor (PVIF)                                    [Reference 8 - Table A-3]
Present Value of stream of future cash inflow 

P = (C1   / (1+i)1  ) + (C2   / (1+i)2  ) + (C3   / (1+i)3  )……+ (Cn / (1+i)n  )

P = Σ C t  /(1+i)^t For  t = 1 to n

C = Cash flow at period 1 to n
Annuity Discount Factor (ADF): Present value of inflow of fixed sum at the end of every 
year. Let the fixed sum be C then

P = C [(1/ (1+i)1  ) + (1/ (1+i)2  ) + (1/ (1+i)3  )……+ (1/ (1+i)n  )]

P = C (Σ 1/(1+i)
P = C (Σ 1/(1+i)^tt )   = C (ADF)
) = C (ADF)
Present Value of Interest Factor Annuity (PVIFA) / Annuity Discounted Factor (ADF) 
[Reference 8 - Table A-4]
Loan Amortization Process – Equated Installment – Loan “P” got today has to be repaid 
outflow at fixed rate “C” every year with a given interest of “I”
C = P/ (ADF)  = P / [(1+i)n  ‐1] / i (1+i)n ]  = [P (i (1+i)n ) / ((1+i)n  ‐1)]

Prepared By S.Nagarajan / Professor / MBS 
7
/ Sudharsan Engineering College

Reference 8 – Example 2.7 [Mr.ArunPrasanth – 02-01-12]

Mr x wishes to determine  the present value of the annuity consisting  of cash inflow of 
an amount of Rs 1000 per year for 5 years. The rate of interest he can earn from 
investment is 10 %. 

Reference 8 – Example 2.9

If ABC company expects cash inflow from its investment proposal it has undertaken in time 
period zero,  Rs 2,00,000 and Rs 1,50,000 for the first two years respectively and then expects 
annuity payment of Rs 1,00,000 for the next eight years, what would be the present value of 
cash inflows ,  assuming a 10 % rate of interest.  

Reference 8 – Example 22.12

12 [Mr.Annathurai
[Mr Annathurai – 02-01-12]

A limited company borrows from a commercial bank Rs 10,00,000 at 12 % rate of interest 
to be paid in equal annual end – of year installments. What  would the size of the 
installments be? Assume the repayment period is 5 years.

Prepared By S.Nagarajan / Professor / MBS 
8
/ Sudharsan Engineering College

4
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

Effective rate of interest discounts:

One lends Rs (1‐d) at the beginning of one year to get back Rs at the end of 1 year – what is 
the value of d? 

d= 1/(1+i)  for one year duration.

If PVIF(i, 1) = 0.95 = 1/(1+i ) then i = 0.0526

d= 1 / (1+0.0526) = 0.05

Hence he will lend Rs 1‐0.05 = Rs 0.95 to get back Rs 1 at the end of the year.

Prepared By S.Nagarajan / Professor / MBS 
9
/ Sudharsan Engineering College

Nominal rate of interest and discount

If the interest is paid in arrears ( at the end of each term) then

effective rate of interest > Nominal rate of interest because of compounding

Coupon rate or nominal rate of interest = i(p)  where p is frequency of payments in a year
Effective rate of interest per year = i = [ 1 + (i(p)  /p) ]p  – 1

If      i(2) = 0.1025 (10.25%) ie coupon rate with 2 times compounding in a year then
Effective rate of interest   i =  [ (1 + 0.1025/2] 2   ) ‐ 1 = 0.0151 = 10.51 % 

If the interest is paid in advance ( at the beginning of each term) then

effective rate of interest < Nominal rate of interest because of compounding

Coupon rate or nominal rate of interest = d(p) where p is frequency of payments in a year
Effective rate of interest per year = i =  1‐ [ 1 + (d(p)  /p) ]p 

If d(p)   = 0.12 ie coupon rate with 12 rimes compounding in an year 
Effective rate of interest = i = [1 – (0.12/12)^12] = 0.1136     

Prepared By S.Nagarajan / Professor / MBS 
10
/ Sudharsan Engineering College

5
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

Profitability Index [or] Benefit Cost Ratio (PI)

Benefit Cost Ratio = BCR = Present Value / Investment

Net Benefit Cost Ratio = NBCR = BCR -1

Initial Investment Rs 100,000
Benefits  Year 1  Rs 25000
Year 2  Rs 40000
Year 3  Rs 40000
Year 4  Rs 50000

BCR =

[(25000/(1.12) + (40000/1.122 ) + (40000/1.123 ) +(40000/1.124 )] / 100000

= 1.145

NBCR = 1.145 -1

A Rs 10,000 per value bond bearing a coupon rate of 12% will mature after 5 years. What 
is the value of the bond if the discount rate is 15%?     [Mr.Ramakrishnan – 02‐01‐12]
May 2007 [Ref 1‐ Page 196]

A patent has been purchased for Rs 17,50,000 has a remaining life of 13 years and Rs 
2,50,000 salvage value. It is estimated that the patent will generate operating 
revenues Rs 3 50 000 per year throughout life Operating cost will be Rs 80 000 per
revenues Rs 3,50,000 per year throughout life. Operating cost will be Rs 80,000 per 
year 2 to 13. Using an interest rate of 12% pa find the present value of this 
investment. May 2007 [Mr.Stallin – 04‐01‐12]

6
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

IRR – Internal Rate of Return

Other names of IRR are:

• Yield on investment
• Marginal efficiency of capital
• Marginal productivity of capital 
• Rate of return
• Time adjusted rate of return etc.,

The discount rate (r) which equates the aggregate present

value of the net cash inflows (CFAT) with the aggregate
present value of cash outflows of a project.
In other words it is the rate at which gives the project NPV of zero.   

IRR – Internal Rate of Return

+ ‐
Where

R = rate off interest
CFt = Cash flow at different time periods
Sn = Salvage value
g p j
Wn = Working capital adjustments 
Cot = Cash outlay at different time periods

7
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

IRR – Internal Rate of Return

Accept – Reject Decision

The use of the IRR as a criterion to accept

p capital
p
investment decision, involve a comparison of the
actual IRR with the required rate of return also
known as the cut-off rate or hurdle rate. The project
would qualify to be accepted if the IRR (r) exceeds
the cut-off rate. (k) .

If the IRR and the required rate of return are equal,

the firm is indifferent as the whether to accept or
reject the project.

IRR – Internal Rate of Return – Problems in computation

1. IRR computation is difficult when the cash flow is not conventional
difficult to find what is IRR – in the following case
-160000+(100000/(1+r))-(100000/(1+r)2
This will give two roots namely 1.25 and 5.00 corresponding IRRs are 25%
aand
d 400%.
00%
2. When two or more projects are compared –
in mutually exclusive projects IRR may be misleading.

3. IRR can not distinguish between lending and borrowing

4. IRR rule says that the project to be accepted if the IRR is greater than
opportunity cost – but how to find IRR if different opportunity costs are found
in different years

8
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

A project costs Rs 36,000 and is expected to generate cash inflows of Rs 11,200 
annually for 5 years. Calculate IRR Reference 6 – Example 9.7
[Mr.Sivakumar – 04‐01‐12].
Particulars Machine A Machine B
Cost Rs 56,125 Rs 56,125
A
Annual estimated income after depreciation and IT
l ti t d i ft d i ti d IT
Year 1 3375 11375
2 5375 9375
3 7375 7375
4 9375 5375
5 11375 3375
Estimated life 5 years 5 years
Estimated salvage value 3000 3000

Find  Average Rate of Return (ARR) / Accounting Rate of Return 
Reference 6 – Example 9.8.
[Miss. Reka – 04‐01‐12]

INFORMATION AND DATA BANK IN 
PROJECT SELECTION
Introduction:
Information is vital for the success of any  
Information is vital for the success of any
organization  and the same is also applicable to 
project
The need of information arises at every 
stage, starting from initiation, planning , 
execution control and up to close out of the
execution, control and up to close out of the 
project 

9
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

DATA BANK:
Data bank mean ,project needs and 
collection of information store in data bank
varies sources of data bank: 
1.process measurement database used to 
collect and make available 
2.project file:(scope, cost, schedule, quality, 
performance measure, 
3.Historical information and lessons learned 
f
knowledge:(project records and documents, all 
project closure information and documentation

Role of inf.. And data bank in project 
selection 

1.Information at initiation stage 

2.Information at planning stage 

3.Information at execution stage

4.Information at control stage

10
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

1.INFORMATION AT INIATIATION 
STAGE
• INFORMATION ABOUT PRODUCT 
DESCRIPTION

• INFORMATION ABOUT FEASIBILITY STUDY

• INFORMATION ABOUT CONCEPT DOCEMENT

• INFORMATION ABOUT PROJECT CHARTER

2.INFORMATION AT PLANNING STAGE
1. Project planning is the most important phase of 
any                                                                         type 
of project
2. The following information will be required as a 
part of system development cycle 
• Work measurement 
• Requirement document 
• Solution document 
• Specification document 
• Design schedules 

11
www.Vidyarthiplus.com
 www.Vidyarthiplus.com 14-Jan-12

3. INFORMATION AT EXECTION STAGE 

• The activities which take place during 
execution phase include (such as information , 
description , project administration , 
procurement, scope, verification and project 
management efforts 
g

12
www.Vidyarthiplus.com