This session covered the following topics and concepts:

● Understand the relationship between the choice of projects and the value of the firm
● Learn how to choose the right project using the NPV method
● Learn how to choose the right project using the IRR method
● Learn how to choose the right project using the payback method
● Learn how to choose an appropriate method for project evaluation
● Understand the effect of choosing a good and a bad project on the value of the firm

From time to time, companies have to make investment decisions, which involve huge finances and
long-term commitments. These decisions are also known as capital budgeting decisions.

Companies have multiple alternative projects to choose from. A good project would increase the
value of a company, and vice versa.

Next, you saw examples of Shambhavi and the Samsung Group to understand this concept better.

Further, you learnt about the weighted cost of capital (WACC). Here is the formula to calculate
WACC.

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Next, you learnt that companies should invest in a project only if its expected returns are higher
than the cost of capital.

In this segment, you learnt how to choose projects using the net present value (NPV) method.
Here is the formula to calculate the NPV.
NPV = PV(Future cash inflows) - PV(Expected cash outflows)
In the NPV method, a project would add value only if it generates more cash inflow than cash
outflow.

The decision to accept or reject a project is based on certain parameters, which are shown below.

Next, you understood the NPV method with the help of an example, which is shown below.

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In this segment, first, you were introduced to another method of project evaluation: The internal rate
of return (IRR) method. Here is the definition of IRR.

Next, you learnt about the relationship between IRR and NPV, which is shown below.

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The decision to accept or reject a project is based on the parameters shown below.

Next, you saw the example of the Samsung Group to understand the IRR method.

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In the example, the IRR was greater than the cost of capital and, so, the firm may accept the project.

In this segment, you learnt about another method of project evaluation: The payback method. In the
payback method, you calculate the payback period, whose definition is given below

A point to note here is that this method does not take into consideration the time value of money
and assume that cash flows that occurred at different times can be compared together.

Here are the decision criteria for this method.

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Next, with the help of the example below, you learnt that to calculate the payback period, you have
to calculate the cumulative cash inflows.

In this segment, you learnt how to choose a project evaluation technique from the three based on
certain parameters, which are given below.

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In this segment, you saw real examples of two companies that went into negative profits due to
incorrect choice of projects.
1. Jaiprakash Associates
Jaiprakash Associates was a leader in hydropower projects, but due to incorrect
diversification into buying race tracks and real estate, the company started incurring huge
losses.
2. Ballarpur Industries
Ballarpur industries was a leading manufacturer of paper, but incorrect diversification into
thermal power plants decreased its profits drastically, thus reducing its shares’ market price
as well.

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In this segment, you saw examples of companies that increased their value due to correct choices
of projects.
1. Page Industries
Page Industries started manufacturing premium products under its famous brand Jockey.
The company also diversified into women’s innerwear while ensuring that distribution was
seamless. This increased its share prices manifold as shown below.

2. Bata
Bata launched the footwear brand ‘Hush Puppies’ to cater to the premium segment. The
company sold the products at premium prices, which helped it earn good margins. This
move increased its profits manifold, and, thus, its shares’ market price also increased, as
shown below.

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