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Mittal School of Business Faculty of MBA

Name of the faculty member: Dr. Nitin Gupta and Dr. Tajinder
Course Code: FINM542 Course Title: Corporate Finance I
Academic Task No: 2 Academic Task Title: Capital Budgeting
Date of Allotment: 19/09/2024 Date of Submission: 6/10/2024
Student Roll No: 12405831, 12406714, Student Reg. No: B42, B43, B44, B45
12406747, 12407191
Term: 1 Section: Q2442
Max. Marks:30 Marks. Obtained:
Evaluation Parameters

Declaration:

I declare that this Assignment is my work. I have not copied it from any other students’
work or from any other source except where due acknowledgement is made explicitly in
the text, nor has any part been written for us by any other person.

Student’ Signature:
1. Kangjam 2. Anurag 3. Divanshi 4. Rudra

Evaluation Criterion: Base on the rubrics with different parameters

Evaluator’s Comments (For Instructor’s use only)

General Observations Suggestions for Improvement Best part of assignment

Evaluator’s Signature and Date:

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PEER RATING

NAME REGN. NO CONTRIBUTION OUT OF

10

Kangjam Unbihalba Meitei 12405831 Page 3, 6-15 10

Anurag Rajithran.M 12406714 Page 4-5 7

Divanshi 12406747 Page 15 - 21 9

Rudra Dev Raushan 12407191 Page 6-7, 22-23 9

TABLE OF CONTENT

SL.NO TITLE PAGE. No

1 Introduction 3

2 Methodology 4 -5

3 Data Collection 6-7

4 Calculation 8-12

5 Analysis 13-22

6 Recommendations 22

7 Conclusion 23

8 References 23
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INTRODUCTION
About Company –

Alpex Solar Ltd. is a prominent Indian manufacturer of solar photovoltaic (PV) panels,
established in 1993. As a pioneer in the renewable energy sector, Alpex Solar has been
instrumental in driving the adoption of solar power in India and beyond. The company's
unwavering commitment to innovation and quality has positioned it as a trusted name in the
industry.

Alpex Solar offers a whole range of solar solutions from the element such as the solar panel,
solar inverter, and mounting systems. Their products are designed to meet the varying energy
needs of residential, commercial, and industrial customers. The company's focus on research
and development has led to the development of advanced technologies that enhance the
efficiency and performance of their solar panels.

Since 2005, Alpex has steadily improved, enhancing its standing as the industry's most
respectable and trustworthy producer of solar photovoltaic panels. Alpex Solar Ltd. is listed on
NSE Emerge.

Mission – “The primary mission of Alpex solar ltd is to facilitate the transition to clean and
sustainable energy by providing high quality and cost-effective solar modules that harness the
energy of the sun to power the world. The mission contributes to a reduction in greenhouse gas
emissions and fossil fuel dependence”.

Vision – “We are committed to driving the renewable energy revolution forward, ensuring a
brighter, cleaner and sustainable future for generations to come. Our vision is to use cutting
edge technology and global invaluable experience to produce the most power efficient solar
modules at the most cost-effective prices”.

About the task –

In this academic task, we will collect various data such as initial investment and annual cash
flow of this company. And we will evaluate Capital budgeting of this company by using
techniques such as NPV, IRR, Payback Period and Profitability Index and we will be providing
proper analysis and recommendations for the decision making of this company.
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METHODOLOGY

The study aims to assess the financial viability and investment potential of Alpex Solar using
various capital budgeting techniques, including Net Present Value (NPV), Internal Rate of
Return (IRR), Payback Period, and Profitability Index (PI). The data required for the analysis
will be sourced from ProwessIQ, a comprehensive database of financial performance data for
Indian companies. Below is the detailed study methodology for the project.

1. Data Collection

• Source: For this report, in order to perform our analysis and calculation, we used
secondary data from ProwessIQ.

• Data Collected: Cashflow statements and balance sheets of the past 7 years.

2. Assumptions

• Project Time Horizon: A specific time horizon of 5 years is selected for the capital
budgeting analysis.

• Discount Rate: The discount rate (usually WACC) will be used to discount future cash
flows for NPV and PI calculations.

3. Capital Budgeting Techniques

A) Net Present Value (NPV)

Objective: To determine the present value of future cash flows generated by projects
of Alpex Solar
Method: The NPV will be calculated using the formula:
NPV=∑(Ct(1+r) t) − I
Where:
Ct = Cash flow in year t
r = Discount rate (WACC)
I = Initial investment
t = Time period

B) Internal Rate of Return (IRR)

Objective: To calculate the rate of return that equates the NPV of the project to zero.
Method: The IRR is found by using the formula –
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𝑁𝑃𝑉 𝑎
IRR = R a + 𝑁𝑃𝑉 𝑎−𝑁𝑃𝑉 𝑏 (𝑅 𝑏 − 𝑅 𝑎)

where,
R a –Lower discount rate
R b – Upper discount rate
NPV a – NPV of lower rate
NPV b – NPV of higher rate
C) Payback Period
Objective: To determine how long it will take for Alpex Solar to recover its initial
investment.
Method: The Payback Period will be calculated by summing the cash flows until the
initial investment is recovered. The formula is:
Payback Period=Year before full recovery+
(Unrecovered cost at the start of the year/ Cash flow during the year)
D) Profitability Index (PI)
Objective: To evaluate the ratio of the present value of future cash flows to the initial
investment.
Method: The PI will be calculated using the following formula:
PI=Present Value of Future Cash Flows/Initial Investment
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DATA COLLECTION

Initial investment cost –

From FY2016 TO FY2017, there is a huge increase in the amount of total fixed assets. So, we
take this increase in total fixed assets as the initial investment.

So, the initial investment = 231.2 – 124.3 = 106.9 million.

Source – ProwessIQ

Annual cash flows for the project's life –

We take the cash flow from FY2018 to FY2022

So, Cash flow in FY18 = 124.3 m, Cash flow in FY19 = 0, Cash flow in FY20= 73.1 m, Cash
flow in FY21 = 15.3 m and Cash flow in FY22 = 41.6 m
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Source – ProwessIQ

Discount rate (cost of capital) –

In the previous report, we have found out that WAAC of this company is 50.8%. So, we take
WAAC as discount rate.

Project life (number of years) –

We assume the project life as 5 years.

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CALCULATION
Net Present Value:
Calculation in excel –

Calculation of NPV
Initial Investment 106.9
Discount Rate, r 0.508
Year Cash Flow (1+r) ^n Cf/ (1+r) ^t
1st Year 124.3 1.508 82.4271
2nd Year 0 2.27406 0
3rd Year 73.1 3.42929 21.3164
4th Year 15.3 5.17137 2.9586
5th Year 41.6 7.79842 5.33441
Sum of Cf/(1+r) ^t 112.036

NET PRESENT VALUE (NPV) 5.13644

Manual Calculation –
We have,
Initial Investment, I = 106.9 m
Discount rate, r = 0.508

Year Cash Flow (1+r) ^n Cf/ (1+r) ^t

1st Year 124.3 1.508 82.4271
2nd Year 0 2.27406 0
3rd Year 73.1 3.42929 21.3164
4th Year 15.3 5.17137 2.9586
5th Year 41.6 7.79842 5.33441

Therefore NPV = ∑(Ct(1+r) t) − I

= (82.4271 + 0 + 21.3164 + 2.9586 + 5.33441) – 109.6

= 112.036 – 109.6

= 5.13644 million
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Internal Rate of Return (IRR)

Calculation in excel
Using Hit and trial Method –

Finding IRR using Hit and trial method

Initial
Investment 106.9
Discount Rate,
r 0.55201

Year Cash Flow (1+r) ^n Cf/ (1+r) ^t

1st Year 124.3 1.552012556 80.0896
2nd Year 0 2.408742973 0
3rd Year 73.1 3.738399337 19.5538
4th Year 15.3 5.802042708 2.637
5th Year 41.6 9.004843131 4.61974
Sum of Cf/(1+r) ^t 106.9
NET PRESENT VALUE (NPV) 0

By using hit and trial method and changing the discount rate multiple times until our NPV
becomes zero, we get a discount rate = 0.55201 where NPV becomes zero.

Therefore, after hit and trial method our IRR is 0.55201 or 55.2%.

Using Formula –

NPV at higher discount rate NPV at lower discount rate

Initial
Investment 106.9 Initial Investment 106.9
Discount
Rate, r 0.53 Discount Rate, r 0.49
Cash (1+r) Cf/ (1+r) Cash Cf/ (1+r)
Year Flow ^n ^t Year Flow (1+r) ^n ^t
1st Year 124.3 1.53 81.24183 1st Year 124.3 1.49 83.42282
2nd Year 0 2.3409 0 2nd Year 0 2.2201 0
3rd Year 73.1 3.5816 20.41 3rd Year 73.1 3.307949 22.09829
4th Year 15.3 5.4798 2.792066 4th Year 15.3 4.928844 3.104176
5th Year 41.6 8.3841 4.961765 5th Year 41.6 7.343978 5.664505
Sum of Cf/(1+r) ^t 109.4057 Sum of Cf/(1+r) ^t 114.2898
NET PRESENT VALUE (NPV
2.505665 NET PRESENT VALUE (NPV a) 7.389785
b)
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Internal Rate of Return (IRR)

Lower Discount rate, R
a 0.49 NPV at R a 7.38979
Higher Discount rate, R
b 0.53 NPV at R b 2.50566
NPV R a - NPV
Rb-Ra 0.04 Rb 4.88412
IRR 0.5505

Manual Calculation –
In order to calculate IRR, we assume that –
Lower discount rate, R a = 0.49
Higher Discount rate, R b = 0.53
R b – R a = 0.04
NPV using lower discount rate, NPV a = {Cf/(1+r) ^t} – Initial Investment
= (83.42282+ 0 + 22.09829 + 3.104176 + 5.664505) – 106.9
= 114.2898 – 106.9
= 7.389785

NPV using higher discount rate, NPV b = {Cf/(1+r) ^t} – Initial Investment
= (81.24183 + 0 + 20.41 + 2.792066 + 4.961765) – 106.9
= 114.2898– 106.9
= 2.505665

Now, NPV a – NVP b = 7.389785 - 2.505665

= 4.88412
𝑁𝑃𝑉 𝑎
Therefore, Internal Rate of Return, IRR = R a + 𝑁𝑃𝑉 𝑎−𝑁𝑃𝑉 𝑏 (𝑅 𝑏 − 𝑅 𝑎)
7.38979
= 0.49 + 4.88412 x 0.04

= 0.5505 or 55.05 %
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Payback Period:
Calculation in excel –

Calculation of Payback Period

Initial Investment 106.9

Year Cash Flow Cumulative Cash Flow

1st Year 124.3 124.3
2nd Year 0 124.3
3rd Year 73.1 197.4
4th Year 15.3 212.7
5th Year 41.6 254.3
Payback Period 10.32019

Profit generated from this

investment 147.4

The company can recover its initial investment in a period of 10 months and 3 days

Manual Calculation –
Initial Investment = 106.9 million
Cash flow of in the five year’s period –

Year Cash Flow Cumulative Cash Flow

1st Year 124.3 124.3
2nd Year 0 124.3
3rd Year 73.1 197.4
4th Year 15.3 212.7
5th Year 41.6 254.3

The initial investment is already recovered in the first year’s cash flow itself.
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
Therefore, Payback Period = 𝐹𝑖𝑟𝑠𝑡 𝑌𝑒𝑎𝑟 𝐶𝑎𝑠ℎ 𝐹𝑙𝑜𝑤 𝑥 12
106.9
= 124.3 𝑥 12

= 10 months and 3 days.

Profit generated from this investment = Total Cash Flow of all 5 years – Initial Investment
= 254.3 – 106.9
= 147.4 million
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Profitability Index (PI):

Calculation in Excel –

Calculation of PI
Initial Investment 106.9
Sum of Cf/(1+r) ^t 112.036
Profitability Index (PI) 1.04804

Manual Calculation –
It is known that,
Initial Investment = 106.9 million
Cumulative present value = 112.036 million
𝐶𝑢𝑚𝑢𝑙𝑎𝑡𝑖𝑣𝑒 𝑝𝑟𝑒𝑠𝑒𝑛𝑡 𝑣𝑎𝑙𝑢𝑒
Therefore, Profitability Index (PI) = 𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡
107.612
= 112.036

= 1.04804
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ANALYSIS
THE FEASIBILITY AND PROFITABILITY OF THE PROJECT -
Interpretation on the value of NPV –

1. A positive NPV of 5.13644 implies that, after accounting for the cost of capital (WACC
of 50.8%), the project is expected to generate a profit of 5.13644 units of value above
the initial investment. This suggests that Alpex Solar's project is financially viable.
2. The WACC of 50.8% is significantly high, indicating a high level of risk associated
with this investment. Despite this, the project still yields a positive NPV, which is a
good sign.
3. Since the NPV is positive, this suggests that it is a good decision for Alpex Solar to
proceed with the investment, as it is expected to add value to the company.

Interpretation on the value of IRR –

1. The IRR (55.2%) is higher than the discount rate or WACC (50.8%), this indicates that
the project is expected to generate returns greater than the cost of capital. It makes the
investment financially attractive, as the company can cover its costs and still have a
significant return.
2. An IRR of 55.2% is high. This indicates that Alpex Solar's project is expected to
generate substantial returns. This level of return suggests the project could be highly
profitable, making it an attractive option for investors.
3. The IRR being relatively close to the WACC (55.2% vs. 50.8%) indicates that even a
small increase in costs or decrease in cash inflows could lower the IRR to a point where
the project might not be as attractive. While it’s still a positive signal, careful monitoring
of project costs and revenue streams is important to ensure that the actual return remains
above the WACC.

Interpretation on the value of Payback Period –

1. The Payback Period of approximately 10.32 months (less than a year) suggests that
Alpex Solar will recover its initial investment within a short time frame. This is a
favourable sign, as quicker payback periods typically reduce the risk associated with
the investment
2. The rapid payback is primarily driven by the strong cash flow in the 1st year (124.3
units), which exceeds the initial investment itself. This large influx of cash significantly
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shortens the payback period, indicating that the project generates substantial revenue
very early.
3. A short payback period improves the company’s liquidity, allowing it to reinvest or use
the recovered funds for other projects sooner.
4. In this case, after the payback period, Alpex Solar generates a total profit of 147.4
million. This indicates the long-term benefits of this project.

Interpretation on the value of Profitability Index (PI) –

1. A PI of 1.04804 means that for every investment Rs.1, the project generates Rs. 1.04804
as present value. Since the PI is greater than 1, the project creates value, suggesting that
Alpex Solar's investment is profitable and expected to return more than the initial cost.
2. A PI above 1, such as 1.04804, is an indicator that the project is financially viable and
should be accepted. It implies that the project will generate 4.8% more in present value
than the amount invested, which makes it a worthwhile investment for the company.
3. While a PI of 1.04804 is positive, it suggests moderate profitability. This might indicate
that the project is not without risk, as the profit margin (4.8%) over the initial
investment is not very high. Therefore, careful monitoring is needed to ensure that the
project stays on track and delivers the expected returns.

THE ADVANTAGES AND LIMITATIONS OF EACH CAPITAL BUDGETING

METHOD USED
Net Present Value, NPV

Advantages of using NPV –

1. Considers the Time Value of Money:

NPV takes into account the time value of money, meaning future cash flows are
discounted to their present value. This makes it a more accurate measure of a project’s
true financial impact over time compared to methods like the payback period, which
ignores the time value of money.
2. Provides Clear Profitability Indicator:
A positive NPV indicates that a project will generate more cash than its cost, while a
negative NPV suggests the opposite. This gives a straightforward decision-making rule:
accept projects with positive NPVs and reject those with negative NPVs.
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3. Accounts for All Cash Flows:

NPV includes all expected future cash flows over the life of the project, offering a
comprehensive view of the project's profitability. It does not ignore any inflows or
outflows, making it a thorough method of evaluation.
4. Directly Related to Shareholder Value:
Since NPV measures the increase in value that a project brings to a firm, it directly
reflects the impact on shareholders' wealth. A positive NPV means the project is
expected to create value for shareholders, aligning with the goal of maximizing wealth.
5. Risk Sensitivity through Discount Rate:
NPV allows for the adjustment of the discount rate to reflect the riskiness of a project.
A higher discount rate can be used for riskier projects, helping to factor in uncertainties
when assessing potential investments.

Disadvantages of using NPV:

1. NPV has difficulty while estimating accurate discount rate:

One of the major challenges of NPV is determining the appropriate discount rate (often
the company’s WACC or opportunity cost of capital). If the discount rate is inaccurately
estimated, it can lead to incorrect decisions about the project’s profitability.
2. NPV ignores project scale:
NPV does not consider the size of the investment. For example, a project with a small
NPV but a low initial investment may have a higher return on investment (ROI) than a
project with a high NPV and large capital outlay. NPV alone may not give the full
picture of a project’s efficiency.
3. It depends on forecast accuracy:
NPV relies heavily on accurate cash flow forecasts. If future cash flows are
overestimated or underestimated, it will significantly affect the NPV calculation,
potentially leading to poor investment decisions.
4. It does not capture flexibility:
NPV assumes that future cash flows are fixed and does not account for the possibility
of management making changes mid-project. Real options (such as delaying,
expanding, or abandoning the project) are ignored in a traditional NPV analysis, which
may overlook opportunities to increase value or mitigate losses.
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Internal Rate Return –

Advantages of using IRR:

1. IRR is simple to interpret:

IRR is easy to understand and communicate. It provides a clear rate of return that can
be directly compared to the company’s required rate of return or cost of capital
(WACC). A project with an IRR higher than the cost of capital is generally considered
a good investment.
2. It considers the Time Value of Money:
Like NPV, IRR accounts for the time value of money by discounting future cash flows.
This ensures that cash inflows and outflows are evaluated in terms of their present
value, leading to more accurate financial assessments.
3. It is useful for comparing different projects:
IRR is especially helpful when comparing the relative profitability of different projects
or investments. It provides a single percentage return that can be used to rank multiple
projects, making it easier to choose the best option when there are several alternatives.
4. It incorporates all cash flows:
IRR takes into account all expected future cash flows, unlike simpler metrics like the
payback period. This makes IRR a more comprehensive measure for evaluating the full
potential of a project over its lifetime.
5. It does not require a predefined discount rate:
Unlike NPV, which requires a predetermined discount rate, IRR finds the discount rate
at which the project breaks even. This can be beneficial when the appropriate discount
rate is uncertain, as the IRR provides a clear cutoff for project acceptance or rejection.

Disadvantages of using IRR:

1. IRR can lead to multiple IRRs:
One of the main problems with IRR is that projects with unconventional cash flows
(i.e., cash flows that switch between positive and negative multiple times) can result in
multiple IRRs. This can be confusing and misleading, as it’s unclear which IRR to use
for decision-making.
2. It ignores the scale of projects:
IRR does not account for the size of the project. A small project with a very high IRR
might look more attractive than a larger project with a lower IRR but a higher NPV.
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This can lead to suboptimal decision-making, especially if a firm prioritizes higher

returns over larger value creation.
3. IRR assumes reinvestment:
IRR assumes that future cash flows from the project are reinvested at the project’s IRR,
which can be unrealistic. In reality, those cash flows are more likely to be reinvested at
the firm’s cost of capital. This assumption can lead to inflated expectations of a project’s
profitability.
4. It is difficult to use for comparing mutually exclusive projects:
When choosing between mutually exclusive projects, IRR can be misleading. A project
with a higher IRR may not necessarily have the highest NPV, and since NPV measures
value directly, it’s generally considered the better decision-making tool for mutually
exclusive investments.
5. It is not reliable for long-term or complex projects:
For projects with long durations or fluctuating cash flows, IRR may not provide the
most accurate picture. Small changes in cash flow estimates can cause significant
variations in the IRR, making it less stable and reliable in such cases. Additionally, IRR
can be more complex to calculate manually, especially for projects with uneven cash
flows.

Payback period –

Advantages of using Payback Period:

1. It has simplicity and ease of use:

The payback period is one of the simplest and easiest methods to calculate. It only
requires basic cash flow data and doesn’t involve complex calculations or assumptions.
This makes it useful for non-financial managers or decision-makers who need a quick
assessment of a project’s viability.
2. It focuses on liquidity and risk reduction:
By focusing on how quickly an investment can be recouped, the payback period
emphasizes liquidity and risk reduction. A shorter payback period suggests that the
investment's risk exposure is lower because the company gets its money back sooner,
reducing the impact of unforeseen risks.
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3. It is useful for high-risk projects:

For projects in high-risk industries or uncertain environments, the payback period helps
prioritize investments that quickly return the initial outlay. This is beneficial when
companies want to minimize exposure to uncertainty or recover funds as soon as
possible.
4. It helps in cash flow management:
Since the payback period emphasizes early cash inflows, it is useful for companies that
have liquidity constraints and need to recover their investments quickly to reinvest in
other projects or meet operational needs.
5. It can be use as decision tool for short-term projects:
The payback period is particularly useful for evaluating short-term projects where the
time frame for returns is limited. For such projects, it helps identify investments that
generate returns quickly, aligning with short-term financial goals.

Disadvantages of using Payback Period:

1. It ignores Time Value of Money:
The payback period does not account for the time value of money (TVM), meaning it
treats all cash flows equally, regardless of when they occur. This is a significant
limitation, as it fails to recognize that money received earlier is more valuable than
money received later.
2. It ignores cash flows beyond payback period:
The payback period only considers cash flows up until the investment is recovered. It
completely ignores any cash flows that occur after the payback period. As a result, it
overlooks the long-term profitability and overall potential of a project.
3. It is not suitable for long-term projects:
For long-term projects that have significant cash inflows after the payback period, this
method may undervalue the project. It focuses on short-term returns, which could lead
to rejecting highly profitable long-term investments that might generate large cash
inflows after the payback period.
4. It ignores risk factors beyond the payback period:
The payback period doesn’t take into account the risks associated with cash flows
beyond the payback period. This can lead to poor decision-making in situations where
significant risks or uncertainties arise later in the project's life, especially for
investments with long-term cash flows.
 P a g e | 19

Profitability Index –

Advantages of using Profitability Index (PI):

1. It considers Time Value of Money:

PI accounts for the time value of money by discounting future cash flows. This ensures
that the value of money today is compared correctly with future inflows, making the
assessment more accurate.
2. PI is easy to interpret:
The PI is simple to interpret. A PI greater than 1 indicates a profitable investment, while
a PI less than 1 suggests the project should be rejected. It provides a clear indication of
whether the project is creating or destroying value.
3. It is useful for ranking projects:
When dealing with capital rationing (limited investment funds), the PI is useful for
ranking and comparing projects. Projects with a higher PI are typically more attractive,
as they generate more value per unit of investment. This helps in allocating limited
resources to the most beneficial projects.
4. It is accounts for all cash flows:
Unlike the payback period, which only considers the time to recover the investment, PI
includes all future cash flows, providing a more comprehensive assessment of a
project's profitability over its entire lifespan.
5. It is consistent with NPV for decision-making:
Since the PI is closely related to NPV (PI is essentially a ratio derived from NPV), it
leads to the same investment decisions. Both metrics ensure projects that add value to
the firm are accepted.

Disadvantages of using Profitability Index (PI):

1. It is difficult to estimate discount rate:
One of the challenges in using PI is determining the correct discount rate. If the discount
rate is inaccurate, the resulting PI could lead to incorrect decisions. Small changes in
the discount rate can have significant effects on the PI, especially for long-term projects.
2. It ignores project scale:
The PI does not consider the size of the project. A small project with a high PI may
seem more attractive than a larger project with a slightly lower PI, even if the larger
 P a g e | 20

project generates significantly more absolute value (higher NPV). This could lead to
suboptimal capital allocation.
3. It assumes constant reinvestment rate:
Similar to IRR, the PI assumes that interim cash flows will be reinvested at the project’s
discount rate, which might not be realistic. If reinvestment occurs at a lower rate, the
actual profitability of the project could be lower than what the PI suggests.
4. PI might not always align with NPV for mutually exclusive projects:
For mutually exclusive projects, PI may not always align with NPV. A project with a
higher PI may have a lower NPV, and since NPV measures the absolute value added, it
may be a better decision criterion for mutually exclusive investments. PI is more useful
when projects are independent, not when choosing between competing ones.

THE IMPACT OF CHANGES IN THE DISCOUNT RATE AND CASH FLOW

PROJECTIONS ON THE PROJECT'S EVALUATION –

Net Present Value (NPV)

A. Impact of Changes in Discount Rate:

Higher Discount Rate: As the discount rate increases, the present value of future cash
flows decreases. This results in a lower NPV, making the project less attractive. A
project with marginal profitability may become unviable if the discount rate is raised.
Lower Discount Rate: Conversely, a lower discount rate increases the present value of
future cash flows, resulting in a higher NPV. This makes the project appear more
attractive.
B. Impact of Changes in Cash Flow Projections:
Higher Cash Flow Projections: If future cash flows are projected to increase, the NPV
will rise since the project is expected to generate more value.
Lower Cash Flow Projections: If cash flow projections are lowered (e.g., due to higher
operating costs or lower revenues), the NPV decreases, indicating reduced project
profitability.
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Internal Rate of Return (IRR)

A. Impact of Changes in Discount Rate:

No Direct Impact: The IRR is the discount rate at which NPV equals zero, so it does
not change with a change in the discount rate itself. However, when comparing IRR to
a required rate of return (like the company’s WACC), an increase in the discount rate
(required return) may cause the project to be rejected if the IRR falls below this new
threshold.

B. Impact of Changes in Cash Flow Projections:

Higher Cash Flow Projections: If cash flows increase, the IRR will increase, indicating
a higher rate of return.
Lower Cash Flow Projections: If future cash flows decrease, the IRR will drop, making
the project less attractive. A lower IRR may fall below the company’s hurdle rate,
leading to a potential rejection of the project.

Payback Period

A. Impact of Changes in Discount Rate:

No Impact: The Payback Period does not take the discount rate into account. It is
simply a measure of how long it takes to recover the initial investment in nominal terms,
so changes in the discount rate have no effect on the calculation.

B. Impact of Changes in Cash Flow Projections:

Higher Cash Flow Projections: If cash flows are higher than expected, the payback
period will be shorter since the project will recover its initial investment more quickly.
Lower Cash Flow Projections: If future cash flows are lower, the payback period will
lengthen, as it will take more time to recoup the initial investment.

Profitability Index (PI)

A. Impact of Changes in Discount Rate:

Higher Discount Rate: As the discount rate increases, the present value of future cash
flows decreases, leading to a lower PI. This makes the project less attractive. A PI less
than 1 means the project is not creating value.
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Lower Discount Rate: A lower discount rate increases the present value of future cash
flows, leading to a higher PI. A PI greater than 1 indicates that the project is generating
more value per unit of investment.

B. Impact of Changes in Cash Flow Projections:

Higher Cash Flow Projections: If projected cash flows increase, the PI will rise,
indicating a more profitable project.
Lower Cash Flow Projections: If projected cash flows are reduced, the PI will drop,
signalling that the project’s profitability has decreased and could potentially fall below
the acceptable threshold (PI < 1).

RECOMMENDATIONS

1. Since the NPV is positive (5.13644), Alpex Solar will generate value for shareholders.
The project is expected to add financial benefits, so moving forward with the
investment is recommended.
2. Regularly review and optimize the discount rate (WACC) used in capital budgeting
calculations. Since Alpex Solar's NPV and PI are sensitive to discount rate changes,
ensuring an accurate and realistic WACC will lead to better investment evaluations.
3. With a short payback period, Alpex Solar should consider reinvesting the early cash
inflows into R&D to innovate and stay competitive in the fast-growing renewable
energy sector, particularly in solar technology advancements.
4. Considering the strong NPV and IRR, Alpex Solar could consider expanding the project
scope to increase the investment size while maintaining similar returns. This will lead
to even greater long-term profitability,
5. Although the NPV and PI are positive, Alpex Solar should perform sensitivity analysis
on the discount rate. A higher discount rate could reduce these values, so it’s important
to monitor economic conditions that may affect the company’s weighted average cost
of capital (WACC).
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CONCLUSION

In conclusion, the capital budgeting analysis of Alpex Solar, using techniques like Net Present
Value (NPV), Internal Rate of Return (IRR), Payback Period, and Profitability Index (PI),
indicates that the solar project is financially viable. The positive NPV of 5.13644 suggests that
the project will add value to the company, while the high IRR of 55.2% demonstrates a strong
rate of return significantly above the cost of capital. Additionally, the short Payback Period of
10.3 months highlights that Alpex Solar will recover its initial investment quickly, providing
the company with liquidity for future investments. The PI of 1.04804 further confirms the
project’s profitability.

Based on these findings, it is recommended that Alpex Solar proceed with the project, as it is
expected to generate substantial financial returns. The company should also consider
expanding similar high-return projects in the renewable energy sector. However, ongoing
monitoring of cash flows, sensitivity to discount rates, and market conditions is essential to
ensure sustained project success and manage potential risks. This comprehensive capital
budgeting analysis provides a solid foundation for Alpex Solar’s strategic investment decision-
making.

REFERENCES

1) https://prowessiq.cmie.com/

2) https://alpexsolar.com/