Project Analysis and Financing Important Questions

Unit 1:
1. “Capital expenditure decision often represent the most important decisions taken by a
firm”. Explain.
2. Discuss six broad phases of capital budgeting.
3. What key issues are examined while making a major investment decisions?
4. Explain the rational for the goal of shareholders wealth maximization.
Unit 2:
1. “A realistic appraisal of corporate strengths and weakness is essential for identifying
investment opportunities” Explain with the important aspects of corporate appraisal.
2. What qualities and traits are required to be a successful entrepreneur?
3. Discuss the sources of positive Net present value (NPV).
Unit 3:
1. How would you evaluate secondary sources of information?
2. Describe the key steps in market and demand analysis.
3. The sales of a certain product during a five year period have been as follows:

Year Sales in Rupees

1 2000
2 2200
3 2100
4 2600
5 2800
6 2700
7 3000
8 3200

a. Find the least square regression line for the data given.
b. Using the moving average method, forecast 4 to 8 year considering 3 year moving
average.
c. Explain the qualitative methods of demand forecasting.
4. Discuss the steps in a sample survey.
5. What information is required for preparing the project implementation schedule?
Unit 4:
1. Describe the components of cost of projects.
2. Explain briefly the various means of financing a project.
3. Discuss the major components of cost of production.
4. How do you select any project based on PBP, NPV and IRR criteria?
5. Your company is considering two mutually exclusive projects A and B.
Project A involves an outlay of Rs 100 million which will generate an expected
cash inflow of Rs 25 million per year for six year. Project B calls for an outlay of
 Rs 50 million which will produce an expected cash inflow of Rs 13 million per
year for 6 years. The cost of capital is 12 percent.
a. Calculate PBP, NPV and IRR of each project.
b. Which project would you select? And why?
c. What is the NPV and IRR of the differential project?
6. You are considering the two projects X and Y each of which requires an initial
outlay of Rs 50 million. The expected cash inflows are:

Year Project X Project Y

1 10 million 25 million
2 15 17
3 18 15
4 24 10

a. What is the Payback period for each projects?

b. What is the discounted payback period if cost of capital is 12 percent?
c. If these projects are independent, which project(s) should you select based on
NPV criteria?
d. If two projects are mutually exclusive and cost of capital is 10 %, which
project should you select?
e. If these projects are independent, which project(s) should you select based on
IRR criteria?
f. If cost of capital is 14%, calculate the MIRR.
Unit 5:
1. What is the best and worst case analysis?
2. Discuss the steps involved in scenario analysis
3. What is financial BEP?
4. What is accounting BEP?
5. We are evaluating a project that costs $604,000, has an 8-year life, and has no salvage value.
Assume that depreciation is straight-line to zero over the life of the project. Sales are projected
at 55,000 units per year. Price per unit is $36, variable cost per unit is $17, and fixed costs are
$685,000 per year. The tax rate is 21 percent and we require a return of 15 percent on this
project.

a. Calculate the accounting break-even point.

b. Calculate the base-case cash flow and NPV. What is the sensitivity of NPV to changes in
the sales figure? Explain what your answer tells you about a 500-unit decrease in projected
sales.
c. What is the sensitivity of OCF to changes in the variable cost figure? Explain what your
answer tells you about a $1 decrease in estimated variable costs.
6. In the previous problem, suppose the projections given for price, quantity, variable costs, and
fixed costs are all accurate to within ±10 percent. Calculate the best-case and worst-case NPV
figures.

7. Ayden’s Toys, Inc., purchased a $435,000 machine to produce toy cars. The machine will be
fully depreciated by the straight-line method over its 5-year economic life. Each toy sells for
$16. The variable cost per toy is $5 and the firm incurs fixed costs of $295,000 per year. The
corporate tax rate for the company is 24 percent. The appropriate discount rate is 12 percent.
What is the financial break-even point for the project?
8. Financial Break-Even James, Inc., has purchased a brand new machine to produce its High
Flight line of shoes. The machine has an economic life of five years. The depreciation schedule
for the machine is straight-line with no salvage value. The machine costs $530,000. The sales
price per pair of shoes is $75, while the variable cost is $27. Fixed costs of $235,000 per year
are attributed to the machine. The corporate tax rate is 21 percent and the appropriate discount
rate is 8 percent. What is the financial break-even point?

Unit 6: What are the principal sources of discrepancies of social cost benefit analysis?
Unit 7: Financing of Project
1. What are the key factors in determining the debt-equity ratio? Explain
2. What are the sources of financing with pros and cons of each source?
3. Discuss the rights of equity holders.
4. How do you differentiate among private placement, Public offering and right offering?
5. Explain the features of debentures.
Unit 8: Venture capital and private Equity
1. Define venture capital Investment.
2. Explain the stages of venture capital
Solution
Problem: The sales of a certain product during a five year period have been as follows:

Year (X) Sales (Y)

1 2000
2 2200
3 2100
4 2600
5 2800
6 2700
7 3000
8 3200
a. Find the least square regression line for the data given. Forecast the sales for next five
years.
 b. Using the moving average method, forecast 4 to 8 year considering 3 year moving
average.
c. Explain the qualitative methods of demand forecasting.

Solution:
a. Least square regression to forecast the sales:

Year (X) Sales (Y) XY X2

1 2000 2000 1
2 2200 4400 4
3 2100 6300 9
4 2600 10400 16
5 2800 14000 25
6 2700 16200 36
7 3000 21000 49
8 3200 25600 64
Total 36 20600 99900 204
The least square regression equation or the equation of time series analysis is:
Y = a + bX
(Where, a = Intercept and b = slope of equation)
Y = dependent variable or sales in units, X = Time in year
∑Y = na +b∑X
∑XY = a∑X +b∑X2
20600= 8a + 36b………………..(1)
99900 = 36a + 204b…………..(2)
Multiply by 9 in equation (1) and multiply by 2 in equation (2), then subtract (2) from (1)
185400 = 72a + 324b
199800 = 72a+408b
Then, - 14400 = -84 b
14400
b = 84 = 171.4286
∑XY−n(Average X)(Average Y) 99900−8×4.5×2575
Or b = = = 171.4286
∑𝑋 2 −𝑛(𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑋)2 204−8(4.5)(4.5)

Put the value of ‘b’ in equation (1), then 20600= 8a + 36(171.4286)

 20600−36×171.4286
a= = 1803.5714
8

Then, Least square equation is: Sales (Y) = a + b (time in year or X)

Forecasted sales for next 5 years:

Year Estimated value

9 3346.43
10 3517.86
11 3689.29
12 3860.71
13 4032.14
b. Calculation of moving average

Year (X) Sales (Y) 3year moving average

1 2000
2 2200
3 2100
2000 + 2200 + 2100 2100
4 2600 3
2200 + 2100 + 2600 2300
5 2800 3
2100 + 2600 + 2800 2500
6 2700 3
2600 + 2800 + 2700 2700
7 3000 3
2800 + 2700 + 3000 2833.33
8 3200 3
 Everest Power Company (EPC) has hired you as a financial expert. Your responsibility is to
analyze projects with the knowledge and experience you have and recommend one of the two
projects since the projects are mutually exclusive. Based on the available information, you
have summarized the following details regarding the cash flows. Initial cash outlay for china
made (Machine A) and Japan made machines (Machine B) and annual estimated cash flows
are:

CFAT
Year
Machine A Machine B
0 -200,000 -300,000
1 64000 66000
2 64000 96000
3 64000 102000
4 64000 81000
5 64000 99000

a. Ignoring discount rate in which year the initial cash outlay will be recovered?
b. Considering discount rate in which year the initial cash outlay will be recovered? The
discount rate or cost of capital is 12 percent.
c. If these projects are independent, which project(s) should you select based on NPV
criteria?
d. If two projects are mutually exclusive and cost of capital is 12 %, which project should
you select?
e. If these projects are independent, which project(s) should you select based on IRR
criteria?
f. If cost of capital is 12%, calculate the MIRR.
g. Among different investment decision criteria, why NPV criteria is the most reliable?
Explain.

Solution:
a. Ignoring discount rate we have to choose the project which has lower payback period (PBP)
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑐𝑜𝑠𝑡 200,000
So, Payback period (PBP) of Machine A = = = 3.125 years
𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝐹𝐴𝑇 64000

(CFAT)
Year Cumulative
Machine B
CF
0 -300,000
1 66000 66000
 2 96000 162000
3 102000 264000
4 81000 345000
5 99000 444000
The PBP lies between 3 and 4 year
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑐𝑜𝑠𝑡−𝐶𝑢𝑚.𝐶𝐹𝐴𝑇 𝑜𝑓 𝑙𝑜𝑤 𝑦𝑒𝑎𝑟
Payback period (PBP) of Machine = 𝐿𝑜𝑤 𝑦𝑒𝑎𝑟 + 𝐶𝐹𝐴𝑇 𝑜𝑓 ℎ𝑖𝑔ℎ 𝑦𝑒𝑎𝑟

300,000−264000
PBPB = 3+ = 3.44 years
81000

Hence PBPA < PBPB so A should be chosen.

b. If discount rate is 12 percent, we have to calculate discounted payback period (DPBP):

Year Machine A Machine B PVIF at 12% PV of A PV of B Cumulative PV of CFAT

1 64000 66000 0.8929 57146 58931 57146 58931
2 64000 96000 0.7972 51021 76531 108166 135463
3 64000 102000 0.7118 45555 72604 153722 208066
4 64000 81000 0.6355 40672 51476 194394 259542
5 64000 99000 0.5674 36314 56173 230707 315714
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑐𝑜𝑠𝑡−𝐶𝑢𝑚.𝑃𝑉 𝑜𝑓𝐶𝐹𝐴𝑇 𝑜𝑓 𝑙𝑜𝑤 𝑦𝑒𝑎𝑟
The discounted PBP = 𝐿𝑜𝑤 𝑦𝑒𝑎𝑟 + 𝑃𝑉 𝑜𝑓 𝐶𝐹𝐴𝑇 𝑜𝑓 ℎ𝑖𝑔ℎ 𝑦𝑒𝑎𝑟

200,000−194394
DPBPA= 4 + = 4.15 years
36314
300,000−259542
DPBPB= 4 + = 4.72 years
56173

Hence DPBPA < DPBPB so A should be chosen.

c. Calculation of NPV

Year Machine A Machine B PVIF at 12% PV of A PV of B

1 64000 66000 0.8929 57146 58931
2 64000 96000 0.7972 51021 76531
3 64000 102000 0.7118 45555 72604
4 64000 81000 0.6355 40672 51476
5 64000 99000 0.5674 36314 56173
Total PV of Cash flows 230707 315714
Less, Initial cost 200,000 300,000
NPV 30707 15714
NPVA and NPVB are positive so, both projects should be chosen.
d. NPVA > NPVB projects A should be chosen.
e. Calculation of IRR
𝐼𝑛𝑖𝑡𝑖𝑎𝑙 𝑐𝑜𝑠𝑡 200,000
For project A: PVIFAIRR, 5 = = = 3.125
𝐶𝐹𝐴𝑇 64000
This factor lies at 18% in the PVIFA table. So IRR of A is 18%.
For Project B: IRR lies greater than 12% because NPV at 12% is positive
Hence Try at 14%

CFATB PVIF@14% Present value

0 -300,000 1 -300,000
1 66000 0.8772 57895
2 96000 0.7695 73869
3 102000 0.6750 68847
4 81000 0.5921 47959
5 99000 0.5194 51417
NPV -13

The NPV at 14% is nearly zero. So IRRB = 14%

Both projects have greater IRRs than that of cost of capital. Both should be chosen if they
are independent.
f. Calculation of Modified International Rate of Return (MIRR)

𝑇𝑜𝑡𝑎𝑙 𝐹𝑢𝑡𝑢𝑟𝑒 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐶𝐹𝐴𝑇 1

MIRR = (𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝐼𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡)𝑁 – 1

CFAT
Year
Machine A Machine B FVIF factor at 12% FV of A FV of B
1 64000 66000 1.5735 100705 103852
2 64000 96000 1.4049 89915 134873
3 64000 102000 1.2544 80282 127949
4 64000 81000 1.1200 71680 90720
5 64000 99000 1.0000 64000 99000
Total Future Value 406582 556394

406582 1
MIRRA = (200,000)5 – 1 = 15.25%
 556394 1
MIRRA = (300,000)5 – 1 =13.15%
g.
NPV considers time value of money, value additive principal, consider cost of capital as
discount factor.