1.

Consider the following cash flows of two mutually exclusive projects for
Tokyo rubber company. Assume the discount rate for rubber company
as 10%
Dry Solvent
Year
Rubber Rubber
0 -1000000 -500000
1 600000 500000
2 400000 300000
3 1000000 100000
 Based on the NPV, which project should be taken
 Based on IRR, which project should be taken
 Based on the above analysis, is incremental IRR analysis necessary? If
yes, please conduct the analysis
 Calculate MIRR

2. You are a financial analyst for The Little Co. Ltd., the director of capital
budgeting has asked you to analyse two proposed capital investment.
Project X and Project Y. Each project has a cost of Rs. 10000 and the
cost of capital for each project is 12%. The project’s net cash flows are
expected as follows
Year Project X Project Y
0 (10000) (10000)
1 6500 3500
2 3000 3500
3 3000 3500
4 1000 3500
 Calculate each project NPV, IRR and MIRR
 Which project or projects should be accepted if they are independent
 Which project should be accepted if they are mutually exclusive
 How might a change in the cost of capital produce a conflict between
the NPV and IRR rankings of the two projects?
 Would this conflict exist if the cost of capital was 5%?
 Why does the conflict exist?

3. Consider the following after tax cash flows of two mutually exclusive
projects for Daily News
 Sunday Saturday
Year
Edition Edition
0 (1200) (2100)
1 600 1000
2 550 900
3 450 800

 Based on NPV method which project should be chosen? The appropriate

discount rate is 12%
 Which project has greater IRR
 Based on the incremental IRR rule which project should be chosen
 Compute MIRR

Based on the above analysis, give your recommendation

4. Consider the following cash flows on two mutually exclusive projects for
Victor Recreation Corporation (VRC). Both the projects require annual
return of 15%

Deep water
Year New Submarine ride
fishing
0 (600000) (1800000)
1 270000 100000
2 350000 700000
3 300000 900000

As a financial analyst for VRC, you are asked the following questions

 Based on NPV analysis, which project should be chosen

 If your decision is to accept the project with greater IRR, which project
should you choose
 Since you are fully aware of the IRR rule, is incremental IRR analysis
necessary?
 Is it consistent with NPV rule
 To be prudent, it is better to compute MIRR for the project, give your
recommendations

5. A firm is considering to buy one of the following two mutually exclusive

investment projects:

Project A:
 Buy a machine that requires an initial investment of Rs. 100000 and
will generate CFAT of Rs. 30000 per year for 5 years

Project B:

Buy a machine that requires an initial outlay of Rs. 125000 and will
generate CFAT of Rs. 27000 for 10 years

Compute NPV using:

 Replacement chain approach

 Equivalent annual NPV approach

Firm’s cost of capital is 12%

6. Mutual Ltd is considering a capital project about which the following

information is available
 The investment outlay on the project will be Rs. 200 million, this
consists of Rs. 150 million on plant and machinery and Rs. 50 million
on net working capital
 The life of the project is expected to be 7 years after which it fetches a
net salvage value of Rs. 48 million whereas a net working capital will be
expected at which book value
 The project is expected to increase the revenue of the firm by Rs. 250
million per year. The increase in cost on account of project is expected
to be Rs. 100 million (This includes all items of cost other than
depreciation, interest and tax). The tax rate is 30%
 Plant and machinery will be depreciated at 25% per year on WDV
method

Should the project be accepted? Assume a discount rate at 12%

7. A firm is currently using a machine which was purchased 2 years ago

for Rs. 70000 and has a remaining useful life of 5 years. It is considering
to replace the machine with a new one which will cost Rs. 140000. The
cost of installation will amount to Rs. 10000. The increase in working
capital will be Rs. 20000. The expected cash flow before depreciation
and tax for both the machine are as follows:

EBIT Existing EBIT New

Year
Machine Machine

1 30000 50000
2 30000 60000
 3 30000 70000
4 30000 90000
5 30000 100000

The firm was straight line method of depreciation. The average tax on
accounts as well as the capital gains and losses is 40%. Calculate the
incremental cash flows assuming sales value of existing machine as
(i) 80000
(ii) 60000
(iii) 50000
(iv) 30000

If the cost of capital is 10%, at what selling price of the old machine that the
firm maximises it’s return

8. A firm is contemplating to invest the following proposal. Advise the

management whether to accept it or not
 Building cost Rs. 12000 (WDV) 10%
 Equipment Rs. 8000 (WDV) 25%
 Net working capital required 10% of sales
 1st year sales (in units) Rs. 20000
 Sales price per unit sold Rs. 3.00 (growth 2%)
 Growth rate in units sold is 5%
 Variable cost per unit Rs. 2.10 (growth 2%)
 Fixed cost Rs. 8000 (growth 1%)
 Life of the project 4 years
 Market value of the building at the end of life Rs. 10000
 Market value of equipment at the end of life Rs. 1000
 Assume cost of capital to be 12% and tax at 35%

9. Tash D company is evaluating 3 investment situation

 Produce a new line of lemon tea
 Expand its existing tea line to include several new flavours
 Develop a new line of higher quality tea

If only the project in question is undertaken the expected present value and
the amount of investment are as follows:
 PV of future
Year Investment required
CFs
1 200000 290000
2 115000 185000
3 270000 400000

If 1 and 2 are jointly undertaken there will no economic benefit, the

investment required and the present value will simply be the sum of parts

With projects 1 and 3 are economically beneficial because one of the machine
acquired can be used in both production processes hence the total
investment. Combined for both the projects are Rs. 440000

If projects 2 and 3 are undertaken, in terms of economies of scale in marketing

and hence the expected present value of future cash flows for both combined
is Rs. 620000

If all the 3 projects are undertaken simultaneously the economic benefits

noted above still hold true, however Rs. 125000 extensions on the plant will
be necessary as the space is not available for all the 3 projects

Advice the management which project/projects should be undertaken

Risk and return in Cash flows

10. A company is evaluating 3 projects A, B and C. calculate Mean NPV,

Standard Deviation of NPV and Coefficient of Variation. Also comment
on the risk of the project
Project A Project B Project C
NPV Pi NPV Pi NPV Pi
(3500) 0.05 (2000) 0.01 (4500) 0.03
(1000) 0.10 0 0.04 (1500) 0.07
0 0.15 500 0.15 0 0.10
2000 0.20 1800 0.20 3000 0.50
4000 0.25 200 0.30 4000 0.25
6000 0.15 2500 0.20 500 0.05
11000 0.08 3000 0.06 - -
17500 0.02 3750 0.04 - -
11. X Cooperation is faced with several possible investment projects for
each project, cash outflow, mean NPV and standard deviation are given
as follows:
Mean
Project Cost SD of NPV
NPV
A 100000 10000 20000
B 50000 10000 30000
C 200000 25000 10000
D 10000 5000 10000
E 500000 75000 75000
 Determine CV for each of these projects, use cost plus mean NPV in
denominator of CV
 What is the probability that each of these project will share NPV of more
than zero
 Ignoring size, do you find some projects are clearly dominated by others
 May size be ignored?
 What decision role would you suggest for the selection of the project
within this context?

12. Consider the following projects which involve an initial cost of Rs.
20000 at time 0. It is expected generate net cash flows during the first
3 years with the probabilities as shown below:

Year 1 Year 2 Year 3

NPV Pi NPV Pi NPV Pi
6000 0.10 4000 0.10 2000 0.10
8000 0.25 6000 0.25 4000 0.25
10000 0.30 8000 0.30 6000 0.30
12000 0.25 10000 0.25 8000 0.25
14000 0.10 12000 0.10 4000 0.10

Calculate the expected NPV and Standard deviation of NPV of the above
project assuming that the cash flows are independent, the risk free
discount rate of the above project is 10%

What is the probability that the NPV is greater than 3000

13. The company is considering a proposal for a purchase of a new machine

requiring an outlay of Rs. 150000000. It is estimated with a cash flow
for the 3 years life of the machine as under
 Year 1 Year 2 Year 3
CF Pi CF Pi CF Pi
800 0.10 800 0.1 1200 0.2
600 0.2 700 0.3 900 0.5
400 0.4 600 0.4 600 0.2
200 0.3 500 0.2 300 0.1

The probability distribution of the cash flows is assumed to be

independent, interest rate is 5%. Calculate mean NPV and SD of NPV

What is the probability of NPV being greater than 0, greater than 2000,
between 1000 and 2000

14. A company has the following discrete probability distribution for net
cash flow generated by a contemplated project
Period 1 Period 2 Period 3
CF Pi CF Pi CF Pi
1000 0.10 1000 0.20 1000 0.30
2000 0.20 2000 0.30 2000 0.40
3000 0.30 3000 0.40 3000 0.20
4000 0.40 4000 0.10 4000 0.10

 Assume independence of cash flows and a risk free rate of 7%. If the
proposal requires an initial outlay of Rs. 5000, determine the mean NPV
 Determine the standard deviation about the mean
 Assuming normal distribution. What is the probability that NPV will be
zero or less?

15. Consider a project which costs Rs. 8000 at t = 0 and is expected to yield
cash flows as follows for three years
Period 1 Period 2 Period 3
CF Pi CF Pi CF Pi
6000 0.10 3000 0.15 6000 0.25
5000 0.40 4000 0.50 5000 0.20
4000 0.30 5000 0.25 4000 0.35
3000 0.20 6000 0.10 3000 0.25

The company feels that cash flows over time are perfectly correlated.
Assuming a risk free discount rate of 10%. Calculate the expected value and
standard deviation of the probability distribution of possible net present
values. Assuming normal distribution, what is the probability of the project
providing a net present value of zero or more

16. A company is considering investing in a new product with an expected

life of 3 years. The company feels that cash flows over time are perfectly
correlated. The cost of the product is Rs. 100000 and the possible cash
flows for 3 years are given below
Period 1 Period 2 Period 3
CF Pi CF Pi CF Pi
0 0.1 10000 0.15 0 0.15
20000 0.2 40000 0.2 15000 0.2
40000 0.4 70000 0.3 30000 0.3
60000 0.2 100000 0.2 45000 0.2
80000 0.1 130000 0.15 60000 0.15

 Assuming a risk free rate of 5%. Calculate the expected value and
standard deviation of the probability distribution of possible NPVs
 Assuming normal distribution what is the probability of the project,
providing NPV of
a. Zero or less
b. Rs. 30000 or more
c. Rs. 100000 or more

17. A company is considering buying a new equipment. The net cash flows
of the equipment hence been estimated as given below the equipment
life is 2 years

Year 0 Year 1 Prob. Year 2 Prob.

80000 0.5
10000 0.4
12000 0.5
20000
16000 0.4
12000 0.6
20000 0.6

The cost of equipment is Rs. 20000 and the cost of capital is 12%. Use the
decision tree approach to recommend whether the equipment should be
bought or not

Multiplication of initial probability (0.6) and conditional probability (0.5)

becomes joint probability
 18. A company is evaluating a new machine with a life of two years. A
machine cost Rs. 3000 and the probability tree of the possible future
cash flows associated with the new machine is as follows:
Initial prob. CF Conditional Prob. CF Branch
0.3 1000 1
0.4 1500 0.4 1500 2
0.3 2000 3
0.4 2000 4
0.6 2500 0.4 2500 5
0.2 3000 6

 What are the joint probabilities of occurrence of various branches?

 If the risk free rate is 10% what are the mean and standard deviation
of the probability distribution of possible NPV
 Assuming normal distribution. What is the probability of the actual NPV
will be less than zero

Scenario Analysis

19. Cash outflow of XY Co., considering an investment of Rs. 3000000 on

a machine will be depreciated by straight line method over the next 7
years of economic life. You are given the following information

Variables Pessimistic Expected Optimistic

Market Size (in units) 220000 240000 260000
Fixed Cost p.a. 1700000 1600000 1500000
Market Share 20% 25% 30%
Selling Price 110 120 130
Variable Cost / Unit 75 70 65

Appropriate discount rate is 12%

Tax rate is 35%

 Calculate NPV of the above scenario

 If each scenario is equally likely is the machine a worthwhile investment
Sensitivity Analysis

20. A company is considering risk characteristics of a project. It has

identified that the following factors and respective values are having a
bearing on Project’s NPV
 Initial cost outlays Rs. 30000
 Cost of capital is 10%
 Quantity manufactured and sold 1400 units p.a.
 Price / unit Rs. 30, Variable cost Rs. 20 / unit, Fixed cost Rs.
3000 p.a., Depreciation Rs. 2000 p.a., Tax rate 50%, Project life
5 years. Salvage value – Nil

Assume the following underlying variables can be taken as shown below

Variables Pessimistic Optimistic

Quantity manufactured and sold 800 800
Price/Unit 20 50
Variable Cost 40 15

Calculate the sensitivity of to the variations in the above variables

Valuation of the Firm

21. Consider 2 companies identical in every aspect except that Company

NL has no financial leverage whereas company L has Rs. 30000 of 12%
bonds outstanding. Both the companies have a net operating income of
Rs. 10000. Assuming you own 1% of the company explain arbitrage.
Cost of equity for company NL 6 15% and company L is 16%
22. Suppose 2 firms U and L have identical assets and expected net
operating income of Rs. 10000, cost of equity of U 10% for L it is 11.7%
Firm L employs 6% Rs. 50000 debt
Calculate the market value of both firms and explain the arbitrage
process
23. Suppose 2 firms U and L have identical assets with EBIT Rs. 150000,
cost of equity for firm U is 15% and cost of equity of firm L is 16%. Firm
L employees 12% Debt it at Rs. 500000
Explain arbitrage process
Binomial Model

24. The current value of the firm is Rs. 100. The annual standard deviation
of the return is 20% and the time is 1 year. Construct binomial module
on the basis of given information
25. The current value of the firm is Rs.100 and the annual standard
deviation is 20% and the time is 1 year. Assume the probability is 70%.
Construct a binomial model.
26. Assume X is Rs. 50, Vtd = 81.87 and rate of return (r) = 5% and time
available is 1 year. Calculate the value of debt and equity of its levered
firm according to binomial model and value of the firm is Rs. 100
27. Using Binomial model find the values of the firm, value of the levered
equity, expected value off the firm, given the values V = 100, U = 1.3, P
= 0.7, t = 3. Consider 2 scenarios where X is Rs. 100 and X is Rs. 50

Black and Scholes model

28. Evaluate the value of the firm according to black and scholes model
considering current price Rs. 100, risk free rate of interest 5%, exercise
price Rs. 50, standard deviation 20% and time 1 year.