Internal Assignment for September 2023 Examination

Subject: Corporate Finance

(Q. 1) Answer:
Introduction-

Net Present Value in Project Management

Net present value (NPV) refers to the difference between the value of cash now and the value
of cash at a future date. NPV in project management is used to determine whether the
anticipated financial gains of a project will outweigh the present-day investment meaning the
project is a worthwhile undertaking.

Generally, projects or investments with a positive NPV will be profitable and therefore given
a green light for consideration, while an investment with a negative NPV will result in a
financial loss, and may not be undertaken.

When NPV is positive, the project or investment will provide a return on your initial
investment. Negative NPV reflects that cash inflows will be lower than the outflows over the
course of the project. NPV of zero indicates that the financial income and output required for
a project will balance one another nearly evenly over the specified time periods.

Some of the most valuable uses of NPV include:

 Determining the future value of a start-up as you prepare to seek investors by building
a discounted cash flow (DCF) model
 Forecasting the cash inflows and outflows over the life of a project
 Deciding whether to make significant purchases such as real estate, equipment, or
software
 Guiding budget allocation for a capital investment
 Analysing whether purchasing or merging with another company would be a good
investment.

NPV formula:

In this formula:

 Cash Flow represents the positive or negative revenue of the project in year “n”
 “r” represents the interest or discount rate
 “n” represents the year
 Initial Cost represents the financial investment in a project
Aradhana Limited has the following 2 investment options:

i) The project requires 1 machine of Rs. 2 lacs with a life of 6 years. There is NIL salvage
value expected at the end of the life. The annual income in each year is Rs. 100000, Rs.
200000, Rs. 250000, Rs. 250000, Rs. 200000, Rs. 120000.

ii) Cost of the project is Rs. 1.5 lacs with a life of 5 years. Salvage value of the machinery
used in the project is Rs. 10000. The annual income in each year is Rs. 80000, Rs. 80000, Rs.
100000, Rs. 250000, Rs. 100000.

Investing in option i) would likely more profitable or greater returns compared to

option ii).

To determine which investment option is more profitable, we need to calculate the net present
value (NPV) for each option. NPV helps account for the time value of money. Here's the
calculation for both options using a discount rate of 10%:

Option i) NPV calculation:

Year 1: 100000/ (1+0.10) ^1 = Rs. 90909.09

Year 2: 200000/ (1+0.10) ^2 = Rs. 165289.25

Year 3: 250000/ (1+0.10) ^3 = Rs. 187828.70

Year 4: 250000/ (1+0.10) ^4 = Rs. 170753.36

Year 5: 200000/ (1+0.10) ^5 = Rs. 124184.26

Year 6: 120000/ (1+0.10) ^6 = Rs. 67736.87

NPV(i) = 90909.09+165289.25+187828.70+170753.36+124184.26+67736.87 – (Initial

Investment cost 2 Lacs)

NPV(i) = Rs. 606701.53

Option ii) NPV calculation:

Year 1: 80000/ (1+0.10) ^1 = Rs. 72727.27

Year 2: 80000/ (1+0.10) ^2 = Rs. 66115.70

Year 3: 100000/ (1+0.10) ^3 = Rs. 75131.48

Year 4: 250000/ (1+0.10) ^4 = Rs. 170753.36

Year 5: 100000/ (1+0.10) ^5 = Rs. 62092.13

Salvage value of machinery after 5 years is Rs. 10000

NPV(i) = 72727.27+66115.70+75131.48+170753.36+62092.13+ (Salvage value Rs. 10000)

– (Initial Investment cost 1.50 Lacs)

NPV(ii) = Rs. 306819.94

Comparing the NPVs:

NPV(i) = Rs. 606701.53

NPV(ii) = Rs. 306819.94

Conclusion:

Option i) has a higher NPV, which means it's more profitable. Therefore, investing in
option i) would likely yield greater returns compared to option ii).

(Q. 2) Answer:
Introduction-
Payback period method:
A payback period refers to the time it takes to earn back the cost of an investment. More
specifically, it’s the length of time it takes a project to reach a break-even point. The
breakeven point is the level at which the costs of production equal the revenue for a product
or service.
PB formula:
Payback Period = Initial Investment / Cash Flow per Year
Evaluating the projects by (PB) Payback period method.

Year A B
0 -4,50,000 -550000
1 1,00,000 135000
2 2,20,000 180000
3 2,45,000 235000
4 1,80,000 200000
5 1,20,000 100000

PB for project A is achieved in less than to year 3 as Rs. 100000 + 220000 + 245000 = Rs.
565000 is greater than initial investment Rs. 450000.
PB for project B is achieved in year 3 as Rs. 135000 + 180000 + 235000 = Rs. 550000 is
equal of initial investment Rs. 550000.
So we can see that PB (Payback period) for project A is less than to 3 years and for project
B is 3 years then project A is preferable to choose since payback of it is less than project
B.

The discounted PB method:

Discounted payback period refers to the time period required to recover its initial cash outlay
and it is calculated by discounting the cash flows that are to be generated in future and then
totaling the present value of future cash flows where discounting is done by the weighted
average cost of capital or internal rate of return.
Discounted Payback Period Formula

Discounted Payback Period = Year Before the Discounted Payback Period Occurs +
(Cumulative Cash Flow in Year Before Recovery / Discounted Cash Flow in Year After
Recovery)
Discounted payback period for project A, with discounting factor 10%.
Year Cash Flow Discount Factor 10% Discounted Cash Flow
0 -4,50,000 - -4,50,000
1 1,00,000 0.909 90900
2 2,20,000 0.826 181720
3 2,45,000 0.751 183995
4 1,80,000 0.683 122940
5 1,20,000 0.621 74520

Discounted PB = 2 + (450000-272620) / 183995

= 2.96 Years

Discounted payback period for project B, with discounting factor 10%.

Year Cash Flow Discount Factor 10% Discounted Cash Flow
0 -550000 - -5,50,000
1 135000 0.909 122715
2 180000 0.826 148680
3 235000 0.751 176485
4 200000 0.683 136600
5 100000 0.621 62100

Discounted PB = 3 + (550000-447880) / 136600

= 3.74 Years
We can see that discounted PB period for project A is 2.96 years and for project B is 3.74
years then project A is preferable to choose since discounted payback of it is less than
project B.

The PI (Profitability Index) method:

The profitability index (PI), alternatively referred to as value investment ratio (VIR) or profit
investment ratio (PIR), describes an index that represents the relationship between the costs
and benefits of a proposed project.

The profitability index is calculated as the ratio between the present value of future expected
cash flows and the initial amount invested in the project. A higher PI means that a project will
be considered more attractive.

 The profitability index (PI) is a measure of a project's or investment's attractiveness.

 The PI is calculated by dividing the present value of future expected cash flows by the
initial investment amount in the project.
 A PI greater than 1.0 is deemed as a good investment, with higher values
corresponding to more attractive projects.
 Under capital constraints and mutually exclusive projects, only those with the highest
PIs should be undertaken.

Profitability Index = Present Value of Future Cash Flows / Initial Investment

PV (Present value) of cash inflow for project A at 10% discount rate is.
PV = (100000 x 0.909) + (220000 x 0.826) + (245000 x 0.751) + (180000 x 0.683) + (120000
x 0.621)
= 654075
Profitability Index for project A,
PI = 654075 / 450000
= 1.45

PV (Present value) of cash inflow for project B at 10% discount rate is.
PV = (135000 x 0.909) + (180000 x 0.826) + (235000 x 0.751) + (200000 x 0.683) + (100000
x 0.621)
= 654075
Profitability Index for project B,
PI = 646580 / 550000
= 1.17
We can see PI for project A (1.45) is greater than PI for project B (1.17) so project A is
preferable to choose.

(Q. 3a) Answer:

Introduction-

Equated Monthly Installment - EMI for short is the amount payable every month to the bank
or any other financial institution until the loan amount is fully paid off. It consists of the
interest on loan as well as part of the principal amount to be repaid. The sum of principal
amount and interest is divided by the tenure, i.e., number of months, in which the loan has to
be repaid. This amount has to be paid monthly. The interest component of the EMI would be
larger during the initial months and gradually reduce with each payment. The exact
percentage allocated towards payment of the principal depends on the interest rate. Even
though your monthly EMI payment won't change, the proportion of principal and interest
components will change with time. With each successive payment, you'll pay more towards
the principal and less in interest.

Here's the formula to calculate EMI:

where

E is EMI

P is Principal Loan Amount

r is rate of interest calculated on monthly basis. (i.e., r = Rate of Annual interest/12/100. If

rate of interest is 10% per annum, then r = 10/12/100)

n is loan term / tenure / duration in number of months

Juhi taken a car loan of Rs. 5,00,000 for a period of 5 year @ 10%.

EMI calculation:

EMI = 500000 x 0.10 x [(1+0.10) ^60 / {(1+0.10) ^60 – 1}]

= Rs. 10624/- per month
Total interest Rs. 137411
Total payable amount Rs. 637411
EMI schedule

Payment Begining Ending

EMI Principal Interest
No. Balance Balance
1 ₹ 5,00,000 ₹ 10,624 ₹ 6,457 ₹ 4,167 ₹ 4,93,543
2 ₹ 4,93,543 ₹ 10,624 ₹ 6,511 ₹ 4,113 ₹ 4,87,032
3 ₹ 4,87,032 ₹ 10,624 ₹ 6,565 ₹ 4,059 ₹ 4,80,468
4 ₹ 4,80,468 ₹ 10,624 ₹ 6,620 ₹ 4,004 ₹ 4,73,848
5 ₹ 4,73,848 ₹ 10,624 ₹ 6,675 ₹ 3,949 ₹ 4,67,173
6 ₹ 4,67,173 ₹ 10,624 ₹ 6,730 ₹ 3,893 ₹ 4,60,443
7 ₹ 4,60,443 ₹ 10,624 ₹ 6,787 ₹ 3,837 ₹ 4,53,656
8 ₹ 4,53,656 ₹ 10,624 ₹ 6,843 ₹ 3,780 ₹ 4,46,813
9 ₹ 4,46,813 ₹ 10,624 ₹ 6,900 ₹ 3,723 ₹ 4,39,913
10 ₹ 4,39,913 ₹ 10,624 ₹ 6,958 ₹ 3,666 ₹ 4,32,956
11 ₹ 4,32,956 ₹ 10,624 ₹ 7,016 ₹ 3,608 ₹ 4,25,940
12 ₹ 4,25,940 ₹ 10,624 ₹ 7,074 ₹ 3,549 ₹ 4,18,866
13 ₹ 4,18,866 ₹ 10,624 ₹ 7,133 ₹ 3,491 ₹ 4,11,733
14 ₹ 4,11,733 ₹ 10,624 ₹ 7,192 ₹ 3,431 ₹ 4,04,541
15 ₹ 4,04,541 ₹ 10,624 ₹ 7,252 ₹ 3,371 ₹ 3,97,288
16 ₹ 3,97,288 ₹ 10,624 ₹ 7,313 ₹ 3,311 ₹ 3,89,975
17 ₹ 3,89,975 ₹ 10,624 ₹ 7,374 ₹ 3,250 ₹ 3,82,602
18 ₹ 3,82,602 ₹ 10,624 ₹ 7,435 ₹ 3,188 ₹ 3,75,167
19 ₹ 3,75,167 ₹ 10,624 ₹ 7,497 ₹ 3,126 ₹ 3,67,669
20 ₹ 3,67,669 ₹ 10,624 ₹ 7,560 ₹ 3,064 ₹ 3,60,110
21 ₹ 3,60,110 ₹ 10,624 ₹ 7,623 ₹ 3,001 ₹ 3,52,487
22 ₹ 3,52,487 ₹ 10,624 ₹ 7,686 ₹ 2,937 ₹ 3,44,801
23 ₹ 3,44,801 ₹ 10,624 ₹ 7,750 ₹ 2,873 ₹ 3,37,051
24 ₹ 3,37,051 ₹ 10,624 ₹ 7,815 ₹ 2,809 ₹ 3,29,236
25 ₹ 3,29,236 ₹ 10,624 ₹ 7,880 ₹ 2,744 ₹ 3,21,356
26 ₹ 3,21,356 ₹ 10,624 ₹ 7,946 ₹ 2,678 ₹ 3,13,411
27 ₹ 3,13,411 ₹ 10,624 ₹ 8,012 ₹ 2,612 ₹ 3,05,399
28 ₹ 3,05,399 ₹ 10,624 ₹ 8,079 ₹ 2,545 ₹ 2,97,320
29 ₹ 2,97,320 ₹ 10,624 ₹ 8,146 ₹ 2,478 ₹ 2,89,175
30 ₹ 2,89,175 ₹ 10,624 ₹ 8,214 ₹ 2,410 ₹ 2,80,961
31 ₹ 2,80,961 ₹ 10,624 ₹ 8,282 ₹ 2,341 ₹ 2,72,679
32 ₹ 2,72,679 ₹ 10,624 ₹ 8,351 ₹ 2,272 ₹ 2,64,327
33 ₹ 2,64,327 ₹ 10,624 ₹ 8,421 ₹ 2,203 ₹ 2,55,907
34 ₹ 2,55,907 ₹ 10,624 ₹ 8,491 ₹ 2,133 ₹ 2,47,416
35 ₹ 2,47,416 ₹ 10,624 ₹ 8,562 ₹ 2,062 ₹ 2,38,854
36 ₹ 2,38,854 ₹ 10,624 ₹ 8,633 ₹ 1,990 ₹ 2,30,221
37 ₹ 2,30,221 ₹ 10,624 ₹ 8,705 ₹ 1,919 ₹ 2,21,516
38 ₹ 2,21,516 ₹ 10,624 ₹ 8,778 ₹ 1,846 ₹ 2,12,738
39 ₹ 2,12,738 ₹ 10,624 ₹ 8,851 ₹ 1,773 ₹ 2,03,888
40 ₹ 2,03,888 ₹ 10,624 ₹ 8,924 ₹ 1,699 ₹ 1,94,963
 41 ₹ 1,94,963 ₹ 10,624 ₹ 8,999 ₹ 1,625 ₹ 1,85,964
42 ₹ 1,85,964 ₹ 10,624 ₹ 9,074 ₹ 1,550 ₹ 1,76,891
43 ₹ 1,76,891 ₹ 10,624 ₹ 9,149 ₹ 1,474 ₹ 1,67,741
44 ₹ 1,67,741 ₹ 10,624 ₹ 9,226 ₹ 1,398 ₹ 1,58,515
45 ₹ 1,58,515 ₹ 10,624 ₹ 9,303 ₹ 1,321 ₹ 1,49,213
46 ₹ 1,49,213 ₹ 10,624 ₹ 9,380 ₹ 1,243 ₹ 1,39,833
47 ₹ 1,39,833 ₹ 10,624 ₹ 9,458 ₹ 1,165 ₹ 1,30,375
48 ₹ 1,30,375 ₹ 10,624 ₹ 9,537 ₹ 1,086 ₹ 1,20,837
49 ₹ 1,20,837 ₹ 10,624 ₹ 9,617 ₹ 1,007 ₹ 1,11,221
50 ₹ 1,11,221 ₹ 10,624 ₹ 9,697 ₹ 927 ₹ 1,01,524
51 ₹ 1,01,524 ₹ 10,624 ₹ 9,777 ₹ 846 ₹ 91,747
52 ₹ 91,747 ₹ 10,624 ₹ 9,859 ₹ 765 ₹ 81,888
53 ₹ 81,888 ₹ 10,624 ₹ 9,941 ₹ 682 ₹ 71,947
54 ₹ 71,947 ₹ 10,624 ₹ 10,024 ₹ 600 ₹ 61,923
55 ₹ 61,923 ₹ 10,624 ₹ 10,108 ₹ 516 ₹ 51,815
56 ₹ 51,815 ₹ 10,624 ₹ 10,192 ₹ 432 ₹ 41,624
57 ₹ 41,624 ₹ 10,624 ₹ 10,277 ₹ 347 ₹ 31,347
58 ₹ 31,347 ₹ 10,624 ₹ 10,362 ₹ 261 ₹ 20,985
59 ₹ 20,985 ₹ 10,624 ₹ 10,449 ₹ 175 ₹ 10,536
60 ₹ 10,536 ₹ 10,624 ₹ 10,536 ₹ 88 ₹0

(Q. 3b) Answer:

Introduction-
DTL (Degree of Total Leverage)
The degree of total leverage is a ratio that compares the rate of change a company
experiences in earnings per share (EPS) to the rate of change it experiences in revenue from
sales.
The degree of total leverage can also be referred to as the “degree of combined leverage”
because it considers the effects of both operating leverage and financial leverage.

Components of the Degree of Total Leverage

The two leverages that degree of total leverage accounts for are as follows:
Operating leverage – This part of a company’s fixed costs reveals how effectively revenue
from sales is translated into operating income. A business with a high level of operating
leverage can increase its bottom line significantly with just a relatively small increase in
revenues because it has effectively leveraged its operating costs so as to maximize profits.
Financial leverage – Financial leverage is a metric used to evaluate the extent to which a
company uses debt to increase its assets and net income. Examining a company’s financial
leverage shows the impact on earnings per share of changes in EBIT that result from taking
on additional debt.

DTL = % Change in EPS / % Change in sales/output

DTL = 6000 (60-30) / {6000 (60-30) – 100000 – 40000}

= 180000 / {180000 – 140000}
= 180000 / 40000
= 4.5
This implies that if there is a 10% increase in sales then EPS will rise by 45%