|, COMPOUNDING TECHNIQUE (THE FUT function is given by:= FV(RATE, NPER, pyr. tp Pe = Rate of Interest URE VALUE FUNCTION): VI, ITYPE]) oe =Noof periods for an investment based on interest rate mut =Used in case of constant payments to be ma pW =Present value of the investment TVPE:0= Payment made at the end of the Period T1?E:1=Payment made at the beginning of the period Note: The double brackets in the PV and ‘Type [] mean this value is optional. de and a constant rate of interest 11, Future Value of a Single Present Cash Flow Problem 1: Mr. X invested a sum of 10,000. at the be ginning of the year at the rate of 10% compounded annually. Whatis the amount that he will get after the end of 3 years? Solution: Steps: 1 Prepare the excel sheet by entering the given information in excel sheet in column B and C, > To find out the future value of this investment, enter the bu -in FV function in Excel Sheet incell C1. Note: To get a positive value, we always put a negative sign in front of the PV (C3) in the function, Altematively, instead of using a negative sign in the function, we can use PV as. 10000 in call C3, 3 The FV is 213,310, Insert Pagetayout Formulas Data_—oReview Vie FVofasingle cash flow Scanned with ComScanner, Financial Management 1.2, Future Value of a series of unequal cash flows: Problem 2: Mr. X invested & 10,000, 85,000 and ® 2,000 at the starting of 1% 2m, and. ot year. Calculate the compounded value of his investment at the end of 3" year when interest is provided at the rate of 10% compounded annually. Solution: Steps: 1. Enter the given information in excel sheet; in column Band C and the rate of interest in cell £1, Line Calloutl1 fe er ee E 1 SOLUTION Rate of Interest 10% 2 3 Year Cash Inflows 4 ol o 5 1 10000 6) 2 5000) 7| 3 2000} 8 2. Find out the future value of each of the cash inflows by using the built-in FV function in Excel Sheet corresponding to each of the cash inflows in column D. Note: If the same value from a cell is used again and again in the formula (such as rate of interest), freeze the value by pressing F4 (which will give a dollar sign to the cell as $ES1) and then use the dragging down utility in excel. 1 sowumion | Rate of interest 2 3 Year | _Cashnflows — [Future Vale [a lo lo . [5 | fh __ftoeeo| -FV(SE51,87-00-C50 2 000 -FV(SES1 5857-106.) NER, PMT [FULITPED) 5 ‘po0o -evSEs1.$857-20,70) _—< ‘Scanned with CamSeanner- actions Time Value of Money 5 ure value at the end of 3 year will be the sum of all the FVs from column D. Home Inte Pagetsyout Formulary Owta Review Re _Formutes Oats Review | SUM Xv fe] =SuM(04:07) a8 > FT | 1 SOLUTION [Rate of interest 10%] 2 | fl Year| Cash inflows [Future Value a of o | | : 1 [10000 D3 | 6 2_[__s000 050 | 7 3 [2000 2200] | | ] FVatthe end 8] of 3rdyear [=sum(04:07) 21560 «—— 4. The future value of all his investment at the end of 3rd year is % 21,560 13 Future Value of a series of equal cash flows Problem 3:Mr. X has invested an amount of ® 10,000 each at the end of Ist, 2nd and 3rd year. Calculate ‘ecompound value of his investment at the end of 3rd year if interest is provided at a rate of 10% compounded annually. Solution: Steps: 1. Prepare the excel sheet by entering the given information in excel sheet in column B and C. Note: This time the PMT is taken as the negative value to get a positive value in the Solution since PV is 0. | 2 Using the built-in FV function in the same manner, we get the future value as € 33,100. Home Insert PageLayout Formulas Data_—Review Present Value ela auauwn wv =FVv(C6,C5,-C7,C3,0)| 33100 BT [ ‘Scanned with amSeanner6 Financial Management 1.4, Future Value when compounding is more than once in a year Problem 4: Mr, Xhasinvested & 10,000 now for3 yearsat the interest rate of 10% per annum compounded semi-annually. Find the amount he will get after 3 years. Also, calculate the future value if compounding is done: (i) Quarterly (fi) Monthly Solution: Since the compounding is more than once in a year, the effective rate of interest will be different from the actual rate of interest given on per annum ba: 1. Enter the given information in excel sheet in column A, B and C. Home Insert 10 2. Adjust the rate of interest and NPER (no. of payments made during the period as per semi-annual payments. Hence, the rate of interest becomes half of 10% becomes double due to payments made half yearly. 2 Rate of Interest o1 payment made semi- 3 Jannually 4 5 Present value 10000 6 Rate =82/2 7 Yea <—— S (NPER, jec7*2 9 PMT of investment) and the NPER The built-in FV function is used in cell C12 to find out the future value as % 13400.96. os = | 1 2 Rate of interest Present vali an Year Neen eae Future value Payment made semi-annually 10000 =82/2 =FV(C6,C8,C9,-C5,0) 13400.96 ee ‘Scanned with CamSeanneryr sappliatons nTime Value of Money 7 to find out future jarly, to find out future values for compounding quarterly and monthly, adjustment is made i 4 Sint f tand NPER a ‘eof interest and ) for quai ‘ i . othera quarterly basis and monthly basis respectively. a Terman Oi) fevew We = FVIG6.G8.68-€5.0) a aa = £ & Ff Gs 1 4 patecofinterest 0.1 Ibayment made SS [semi-annually aad 4} monthly a 5 Preventvalue_| one) 10000 sme fe ays fox} 7 Year 3 3 3 same? as [era 7 sm |? 0 b 1 0 iu _ 12 Tuturevaloe sFV(C8.08,09-€3.0) =FE68,0-45,0) Fresca 659 | » « 1100.36 ens aa.82 6 ais Problem 5: Mr. X has invested & 10,000 now for 3 years at th @ interest rate of 12% per annum compounded quarterly. Find the amount he will getafter 3 years. Solution: The Future Value is found out in ——— © + fe | =FV(CA,C5,C7,-C3,0) the same manner but putting the built-in FV function. c i Rate of Interest 10000 3% ‘Scanned with CamSeanner8 Financial Management 2. DISCOUNTING TECHNIQUE- THE PRESENT VALUE FUNCTION The PV function is given by: = PV(RATE, NPER, PMT, [FV], [TYPE] ) Rate = Rate of Interest NPER =Noof periods for an investment based on interest rate PMT = Used incase of constant payments to be made and a constant rate of interest FV = Future value of the investment TYPE: 0= Payment made at the end of the period TYPE: 1= Payment made at the beginning of the period 2.1, Present Value of a Future Sum Problem 6: Mr. X is supposed to get® 10,000 after 3 years. Let the existing rate of interest is 10%, find the present value of this sum. Solution: Steps: 1. Prepare the excel sheet by entering the given information in column B and C. __€10 2 A [Te D E 3 4 Future Value (FV) 10000 5 Years 3 6 NPER 3 7 Rate 10% a ; 2 . 3 : 4 5 6 7 s 3 [Present vaive 10 4 a D a Present value 7513.15[answer_| Note: To get a positive value, we always put ro . built-in function. Ys put a negative sign in front of the FV (C4) in the Iternatively, instead of usi ive sign i : a aca Ny, i ing a negative sign in the function, we can enter FV as -10000 Scanned with CemScanneryr agplatons in Time Vale of Money 9 ane value of a Series of Unequal Cash Flows jem 7: Mr. X has to receive a sum of & 10,000, € 5,000 and & 2,000 at the end of 1st, 2nd, and 3rd Lana ‘an investment proposal. Calculate with the help of excel, the present value of his future cash Gs rom this investment proposal if the rate of interest is 10%. olution: Steps 1, Enter the given information of rate of return, cash inflows and outflows on the excel sheet. CTIA vome_ nv ae Layout Formulas Dats Review View 9 value [=NPV(02,84:86) Net Present 11 value 14725.77 Answer 2 2sert the built-in NPV function as given in cell B9 and get the net present value. Atemat; 'matively, Steps: 1. Same as above 2 Ring 1 2 aces 2 Year . cash intiows [pv “8 10000 -pv(s052,A4,0,-84,0) S32 ‘5000 -=PV($0$2,A5,0,-85,0) $3 2000 =PV($0$2,A6.0,-86,0) 7 ‘Scanned with CamSeanner0 Financial Management oT Se | =SUM(C4:C6) Alsons Sti voorun [=serecoes too 5 A cae aes all 3 2000, z\ The present value of all his investment is € 14,725.77 2.3, Present Value of a Series of Equal Cash Flows Problem8: Mr. X wishes tocalculate the present value of the annuity consisting of a cash inflow of 10,000 per year for3 years. The rate of interest he can eam is 10%. Solution: Steps: 1. Enter the given information on the excel sheet with regard to rate of return, PMT, NPER and year, 2. Find the present value by using the PV function. 2 | 3| Future value ai 5 6 7, Al 9 9 | L [20 | Present value [=PV(C6,C5, ) 24868.52 | a2} [PvGste nper pret 11 Typed | 24. Present Value of Perpetuity Perpetuity is defined as an infinite series of equal cash flows occurring at regular intervals of ime. T0 find the present value of perpetuity, divide the annuity by the rate of interect. For more clarity, refer to the following illustration: Problem 9: Mr. X, a wealthy businessman wants to institute a scholarship of & 10,000 p.a. for an tanding academic performance in an educational institution. He wants to krow thesum of mone he has to invest at 10% rate of interest so that it yields & 10,000 P.a. in perpetuity. ‘Scanned with CamSeannery seins Tine We of Money te AP ee tion? A ig vathiscase for annuity of € 10,000 @ 10% rate of interest is found to be € 1,00,000. fr > 1! Annui Rate of interest | 10%, | (PV of Annuity if ithe ROLis12% —_[=C4/C5 100000 24 Future Value of an Annuity Due ieananuity that is due, the type in the FV function (=FV(rate, NPER,PMT,[PV][TYPE]) is chosen to ‘instead ofO given the payment is made in the beginning of the period. Poblem 10: Mr. X made a recurring deposit of 10,000 in the beginning of each of 3 years starting now 21%pa. What amount he will receive after 3 years? Sclution: Steps: : Prepare the excel sheet by entering the given. Thefuture value is found by using the built-in information. FV function. The typeis chosen to be 1 instead of 0. | FV of annuity | (made in the 10} aFv(C6,C5.-C7,C3,1) 36410 { beginning) amen) rate, nper, pet (PI, Scanned with ComScanner7 Financial Management 2.6. Present Value of an Annuity Due i is inning of next 3 year starting f Problem 11: Mr. X has to receive an amount of & 10,000 in the beginning of starting from now froma sum invested at 10% p.a. rate of interest. Find the present value of the sum invested, Solution: ‘The solution to this question is worked out in the same manner by using the built-in PV function SUM To WIC6,C5,-C7,63.4) 7 a oe | al jsowuTion \ ovouaune PV of Annuity | (made In the | 2) beginning) <3, 27355.37 10 3. The PMT Function: The PMT function calculates the payment for a loan that has constant payments and a constant interest rate. Whenever the amount of deposit is paid back in equal instalments, it is the annuity payment or PMT. To find the amount of an annuity, the PMT function is used as: = PMT (rate, NPER, PV,[FVI.[Typel) Problem 12: Mr. X deposits & 5,00,000 on his retirement in a bank on which interest is provided at the rate of 10%p.a. How much money in equa instalments can be withdrawn annually ora period of10 years Solution: The amount of installment is found by using the built-in PMT function: {sum 7 A *_Y _& | =PMT(B4,86,-83,0,0) SOLUTION — a a BT) Present Value 10 |Instalment a 20 =PMT(B4,86,-83,0, 4 81372.7 PMT (rate nper pv, [fv feypel ‘Scanned with CamSeannersacl Applications in Time Value of Money plem 13: Mr X is to retire after 29 ; Francia needs afterretirement: —2°3"S ftom now. He has the following ideas for meeting his , tosave and invest @) Hewants est equal sum ann 20 years. How much should he save art ually HA 13 to accumulate a lump sum of 8 20,00,000 after Per annum in 20 such installments if he starts it in ifter investing after one year from now. Assume the rate of interest on investment at 10%p.a * quarterly pension in annuity. First pension is to b received after first quarter of his retirement. H. ” ity. First pension is to be Find out the amount of quarterly eas ‘© expects to live for 15 years after his retirement. Solution: (i) om [Rate of interest lev lYear INPER. Fv To find the amount of yearty installment (investment made at the end of the |) year) x 2919.2095450016 Prat cate: nper pv. ype (ii) F | =PMT(C2C5,C3,-C6.1) a 8 T c— Rate of interest loa Pv lo [Year [20 INPER Pao ev ‘To find the amount of yearly installment (investment made at the end of the on year) =PMT(C2,C5,C3,-C5,0) 3919.24 To find the amount ot yearly installment (investment made at the beginning of ay the year) Scanned with CemScannermn Financial Management (iii) Fe | =PNT(CHSIACHT, Rate of interest Pv lvear INPER. FV. 3) Rate of interest feos aa pv 1s Year 15 16 Payment period (Quarterly) 4 "7 NBER pcasci6 »] Amount received ater est quarter BNT[CIa7aCT7-CIOO) [s7515.02 Problem 14: A person has been given the following options for the investment made by him in the past, Select the most attractive option assuming the discount rate of 10.5% p.a (a) %5,50,000 tobe received at present time. (©) %16,00,000 to be received after 10" year (©) %62,500 receivables per annum in perpetuity _(d) % 90,000 receivables p.a. for 10 years (©) %50,000 receivable half yearly for 4 years and ® 3,50,000 after 5" year Solution: (a) The PV is same as % 5,50,000 as For subsequent parts, we use the built-in PV function in Excel Sheet: [ Bu =o Fe) 815015 4a) PV is sameas given in the question 5,50,000 ANSWER 1 PV of 16,00,000 to be received after 10th 6b) year =PV(C3,10,0,-1600000,0) $89518.18, 7 alg PV of perpetulty of 62,500 =62500/¢3, 595238.096 3 PV of 90,000 received per annum for 10 10 4) years =PV(C3,10,-20000,0,0) $4132.54 PV of 50,000 receivable half yearly for 4 ae) ‘years and 3,50,000 after Sth year a at For ayears, p ‘or Sth year $s [=P v(C3/2,4"2, 5000004 a 3/2,8°2,50000,0,0), 'V(C3,5,0,-330000,0 PV of $0,000 receivable half yearly for 4 ” ‘years and 3,50,000 after Sth year [eB15+015 s32360.75 Scanned with ComScannerEXCEL APPLICATIONS IN CAPITAL BUDGETING DECISIONS valuation of Projects based on: (i) Payback Period (ii) Average Rate of Return (ii) Net Present Value (iv) Profitability Index (v)_ Internal Rate of Return (vi) The Case Of Conflicting NPV vs IRR (vii) Discounted Payback Period (i) Payback Period: The payback period is the length of time for an investment to recover its initial outlay in terms of profits or savings (a) When equal cash inflows are generated every year ie., when the cash flows are in the Initial investment form of an annuity: Payback period = tial investment _ ty: Payback period = ual eash inflow (b) When cash inflows are unequal: Payback period = P + 2 Where, P = No. of years immediately preceding the year of final recovery. B = Balance amount to be recovered in the year of final recovery. C = Cash inflow in the year of final recovery. Problem 1: A project requires an outflow of ® 40,000 and the expected inflows generated from the project are & 10,000, & 12,000, & 10,000, % 7,000, and & 5,000 for the next 5 years. Calculate payback Period. Solution: Steps: 1. Enter the given information in excel sheet; thus, year in column A, cash inflows in column B and initial cash outflow in cell C2. 2. Compute cumulative cash inflows in column D. Initial Cash Inflow 40000 ; Cumalative Cash Inflow Cumalative Cash Inflow Inflow Cash in a [22000 "10000 C5486 32000 7000 C6187 39000 5000 —_ “ a et Scanned with ComScanner16 3. Finally, calculate the payback period as given in cell C11: Financial Managemen SUM vo xv | A SOLUTION Initial Cash Inflow Year Cash Inflow 10000 12000 10000 wae ne =AH{C2-C7)/88 ‘Cumalative Cash Inflow 7000) 39000] 5 44000 10000 22000 32000 Payback Period 42 Gi) Average Rate of Return (ARR): It is computed by dividing average annual profits(after tax) by the average investment in the project. Rule: ARR _ __ Annual profit afte Average investmen ) project 100 Ifthe Average rate of return > the pre specified /desirable rate of return; Accept the proposal Ifthe Average rate of return < the pre specified /desirable rate of return; Reject the proposal Problem 2: ABC Ltd. is planning to purchase a machine costing ¥ 60,000 and having a salvage value of ® 8,000, The economic life of the machine is 5 years and it is likely to give following earnings after tax. Year 1 2 3 4 5 Profit after-tax & 6,000 7,000 5,000 6,000 8,000 Using ARR method, should the machine be purchased ifthe comp, Solution: Steps: any’s required rate of return is 20%. 1, Enter the given information in excel sheet; thus, cost of the machine in cell C2 and the given rate 2. Next,compute the average profit and avera 3. Finally, In this case, ABC Ltd. should not buy rate of return ie, 20%. year in column A, profits after tax in column B, of return as 20% in B10. : ige investment as ven in cell C12 and C14 res] tively: ARRis calculated as average profit (after-tax) diay, ™ ) divided by average investment. ' the machine as the ARR (18.82%) is less than the pre-specified Scanned with ComScannerrr sce! Applicat tions in Capital Budgeting Decisions 7 [Home Invert Page tsyout Formulas Data Review View ca TA Os*(c2 ee a 8 oe 3 ae 1 SOLUTION | A Cost of machine [50000 Salvage value {3000 ' a Year Profit After Tax | lacs ‘6000 512 7000 63 5000 74 6000 35 8000 9 Required rate of 10 return 02 Average Profit =(84+85+06+07+B8)/5 6100 Average Investment ii) Net Present Value : The Net Present Value function is used when a series of unequal cash flows occur. The NPV function is given as: =NPV (Rate, Range of Cash Inflows) + (-Cash outflow) | Rule: If the computed value is positive, accept the proposal and if the value is negative, reject | the proposal. | Problem 3: RS Ltd. is planning to buy a machine for & 1,00,000. The cash flow after tax from this | machine in the next five years will be as follows: Year l 7 2 3 4 5 L_crare | 26,000 29,000 zo | 35,000 38,000 Usig NPV method, give your advice whether the machine should be purchased if the cost of capital 510%, . Solution: Steps: 1. Prepare the excel sheet by entering the given information (year, cash outflow, cost of capital and cash inflows ) . a a negative figure in order to get a positive answer, Note: The cash Outflow is to be shown as 2 Enter the built-in NPV function in cell C11. ‘Scanned with CamScanner. Financial Managemen, PUGET] wone teretPagetayoutFomulas Data Revew View ‘SUM + & fe) =NPV(D3,B5:89)+02_ 7 = T cc... — G 2 Cash outflow 3 Cost of Capital 4 Year rar 5s) oa 26000 6 2 28000 7] 3 32000 84 35000 os 38000 |10 ni) NPV [-npvi03,85:89)+02 | 19145.86 2 NPV(ate, valuel, [valued], valued], .) B In this case, RS Ltd should buy the machine as the computed value of NPV in cell C11 is positive. Gv) Profitability Index: It is the ratio of the present values of all cash inflows associated with a project to the present values of its cash outflows. It is given by: PI= Sum of present values of cash inflows Sum of present values of cash outflows Rule: If PI >1, Accept the proposal and If PI<1, Reject the proposal Problem 4: From the information given in Problem 3 comment if your answer will be the same on the basis of profitability index method. Solution: Steps: 1. Prepare the excel sheet by entering the — given information (year, cash outflow, cost of capital and cash inflows ) Note: Cash outflow to be shown as negative. 2. Tocompute the PI, find the NPV of cash inflows and divide it by cash outflows. Note: D2 is considered as negative to get a positive value in the answer Since it is seen that Pl>1, the proposal should be accepted on the basis of this method also. Page yout TRV Formulss Ova -NPV(D3,85:69)/-02 Cash outflow Cost of capital ‘Scanned with CamSeannerae scl Applications in Capital Budgeting Decisions 19 (Internal Rate of Return Method: Itis defined as the discount rate that equates the present value of expected net cash inflows from an investment proposal to the present value of its initial cash outflow. The built-in IRR function in excel is given by: = IRR (range of cash outflow and inflows) Rule: FIRR< required rate of return, reject the proposal and If IRR> Required rate of return, accept the 1. proposa! ee j Problem 5: SR Ltd. is considering investing in a project requiring a capital outlay of € 1,00,000. Forecast for cash flow after tax are as follows: Year 1 2 3 4 5 [ae |__ 2 CFAT ¢ 40,000 40,000 20,000 40,000 40,000 Project's salvage value is zero. Calculate internal rate of return and advice the company whether to invest in the project if desirable rate of return on its investment is 20%. Solution: Steps: 1. Prepare the excel sheet by entering the given information. 2, Enter the built-in IRR function in cell B12, select the range of cash outflows (negative value) and inflows and hit enter. In this case, we reject the proposal since IRR< the required rate of return. A | 8B ce | oD Cash outflow 100000 Cost of capital 20% CFAT -100000] 40,000] 40000 TRR(values, [guess)) \ NA The case of conflicting NPV and IRR: "em 6: Hunny Proj is evaluating : Hunny Projects Ltd. is eval peCompanys required rate of return from such pr IS is as follows: two mutually exclusive investment proposals X and Y, jects is 10%. The pattern of cash flows for both the ‘Scanned with CamSeannerFinancial Managemen, 20 Year 0 1 2 3 CrAT® Project X 60,000 50,000 25,000 5,000 CrAT? Project ¥ 60,000 5,000 30,000 55,000 Evaluate the proposals as per NPV and IRR methods. Solution: Steps: 1. Enter the given information on excel sheet. 2. Determine the NPV and IRR for the two projects individually and compare the same, On the basis of NPV, it is advised to select project Y since NPV of Project Y>NPV of Project X, On the other hand, on the basis of IRR, Project X should be selected since the IRR of Project XIRR of Project Y. ao Page tyet formule Fe | =NPVIER.CB: ca)+CS oo D E 9872.28 10661.16 1 2 sownon rate 3 ‘ Yew x ¥ : a re00 Heo s ft S000 S000 7 B 000 000 8 B ooo 000 3 0) new FROST ver 6:08)05 15, W = Sa a c E ° E 2 SOLUTION Rate on ; ak i La ee ise iss 1 Ser Sor fn: Sy Sas | bere Naecccmes mann 2c" oe 7 33, Si jscsen 7 ea : In case of conflict between NPV and IRR methods, the tesults given by NPV methods is used. ‘Scanned with CamSeanner ke~~ sxc Applications in Capital Budgeting Decisions 21 (vi) Discounted Payback Period ‘fis method is similar to the traditional method except that under this method, the present values of ash inflows and outflows are used instead of only cash flows under traditional payback period method. re problem 7: RST Ltd. is considering investing in a project requiring a capital outlay of € 1,00,000. Forecast for CFAT isas follows: i | 1 | 2 | 3 4 | 5 oe | craT’? =| 60,000 50,000 30,000 | 20,000 Find the discounted payback period of the project assuming a discount rate of 10%. Solution: Steps: 1. Enter the given information on the excel sheet. 2. Compute the present values of the given cash flows after tax as given in column D by using, the built-in NPV function 3, Compute the cumulative cash flows as we do in the traditional payback period method. Home Insert Page Layout Formulas. «Data. = Review = View fe 208-07 8 — ¢ et 1 SOLUTION Rate of Interest 01 ai Initial Cash Outlay 100000 Cumulative Cash 2 Year cFAT PV of Individual CFAT Flows 4 1 60000 ‘=NPV(SESI,C4) =D4 | 18 2 0000 =NPV(SESI,C4:C5)=05-D4 6 =NPV(SESI,C4:C6)__=D6-D5 3 40000 (SES: ul 4 30000 '=NPV(SES1,C4:C7) [2] 5 20000 9 ‘. Finally find discounted payback period by using the traditional formula as: B Payback period =P + ‘Scanned with CamSeannerFinancial Managemen BR 8 010 a a a [aA 8 1 SOLUTION Rate of Interest on PV of Individual Net 3 Year CFAT PV of Cumulative CFAT Cash Flows 4 1 ‘60000 NPV{SES1,CA) 04 5 2 ‘50000 NPV(SESL.C4:CS) D4 6 3 40000 =sNPV(SES1,C4:C6) 16-05 1 7 4 30000 =NPV(SES1,C4:C7) =D 8 3 20000 =NPV(SES1,C4:C8) 9 10 Discounted Payback Problem 8: A Company is considering as to which of the two mutually exclusive projects should be undertaken. Project A costs = 2,00,000 and Project B costs & 2,20,000. Both the Projects have the same life of 5 years. The company anticipates a cost of capital of 10 per centand the after tax cash flows are % 80,000, % 80,000, € 60,000, % 60,000 and % 20,000 for the next 5 years for Project A and % 50,000, & 50,000, % 60,000, € 90,000 and ¥ 90,000 for the next 5 years for Project B. Assuming a 10% cost of capital, determine for both the projects, the: (i) Payback Period (i) Profitability Index Which projects would you recommend? Solution: Step:1 G10 2 AB c Die desea |inree Gs selene uy 4 1 SOLUTION _ - 2 Project A Project B Initial ca ; ne Cost of ; lay 200000 220000 Capital 0%, ‘Cumulati a Year ve Cash ‘Cumulative Cashinflow inflow Cash inflow Cash Inflow 6 1 80000, 80000 50000 50000 7 2 80000, 160000 50000 100000 8 3 60000, 220000 60000 160000 13 4 60000 280000 30000 10) Ss 20000 oo n — 30000 ‘Scanned with CamSeanner— SENS Decisions 23 tics ee) : Comoteaal 01 caanten on a Wow 0 1 wom ‘e009 Canhintion Camulative Cash ntl 7 2 om 1000 ae ooo 0 on 2009 ao 300 ar) = ss nies nom Pser0) in 0 om ae a 3 pe Poe caonica uw ze Ge bys Step:3 a , ™ cute Cah ie 1 Cattow tefow Gash nfow Comelatve Cash inflow y 0 00c0 sto #000 : ero wot sooo ane f xn zo ed st eS fo 2st son 0 a 200 earn sumo se & n [4 Pvtainy > sans un o ty precip —Jurines snows dems » ob oe te rai 9:SR Ltd. is considering two additional mutually exclusive projects. The cost of each of % 1,00,000. The after tax cash flows in % associated with these projects are given in Ne table. mw ‘Scanned with amSeannerFinancial Management 24 Year 1 2 3 4 5 | Project 32,000 20,000 32,000 35,000 45,000 Project BZ 0 0 ° 0 2,00,000 ‘The required rate of return on these projects is 11%, Advise as to which project should be chosen by way of: (a) NPV (b) IRR (c) Payback period Solution: Step: 1 camer — on é 7 A 2 sownon : rc Tet ama Ga — et [eam i [om am f r is fz iz a B 0 ose fo 6a 5 poo ones 0 seren ls i sooo Eom o rs ho 5 sooo Focie nooo em) hs | hz futeotretun 011 vw snviscsizsiin}ses snoviscsiz sen) 165 | me snn(esc19) 650) pea satontsyen9 Step: 2 3 4 Year| Project A_|[ Cumulative Cash Flows] Projects [Cumulative Cash Flows 5 o 100000 cone { 6 2 32,000 33,000 a 7 ‘ 7 2 20,000. 32,000 = <. : : > 33,000 : S « 33,000 2 2 i 38. 3 25,000. 200000. 360060 f nate of | a2 return on i 2 I 340) NPV 8220.30 ae96a9 i isp) me 740% tas k Payback 18 jc) period 2. aso} { ‘Scanned with CamSeannerat Applenions in Capital Budgeting Decisions 25 ste, The estimated profit before depreciati ss s Thee P “Preciation and tax (PBDT) from the investment proposal T Year | 1 2 -——— | : = = | pBoT® 11,000 20,000 180,000 15,000 12,000 Calelate the following: () Payback period. (i) Averagerate of return. (ii) Net present value at 10% discount rate. (iv) Profitability index at 10% discount rate. (0) Internal rate of return. ; Solution: Steps: 1. Prepare the excel sheet by entering the given information 2. Prepare the schedule for cash flows after tax by computing profit after tax and adding the depreciation to it 3. Find out cumulative cash flows I, ! Prftefne depreciation and Depreciation Proftbefoetar Profitaer te) ; = Lsktc) (CO) CATH) Cumaatve CAT ft Yer tee) gam) a) (a8) 1 to 0 oh 385 SB | : 2 000 10000 4606 sites 66 36005 SiH : nfl oH) 6H , 3 100 10100 a HT t 4 1000 000 a | fe aus ! sap RH x j 20 0000 GH index and Internal Profitabi a te Payback Period, Average rate of ee ba ae eared in problems. ‘te of return are then computed in the s# ‘Scanned with CamSeannerFinancial Managemen 26 — = | ana 1 soumow —— ha a 000. 1 CashOutow yom__]} 3 rit bere depreiton nd Frotbetretax rot atest) 4 Yea ta (P80) (4) Depeciton (sno) (8) (C248) Tar) (15H"C) dl CAT(BE) —Comaltie cat $ 1 nm a) 00 ey) neo 180 ‘ 2 amo oo 0000 30 0 mn 7 3 100 emo om wn 0 sa ' 4 smo 000 0 re 7) ns Same : 5 mm 0000 a0 ™ a jun v 8 3 2 |20 a lil) Net Present Value NPV 1) Profitability index Year 1 2 3 4 5 1 vv) Internal rate of return, Year o 2 2 3 4 5 IRR Discount Rate =NPV(D17,HS:H9)+(-€2) Discount Rate CAT (B+E) 10650 16500 15200 13250 11300 pamper crat 04.51 on Present value of Cash flows =PV($0$21,823,0,-C23,0) -=PV($0$21,824,0,-C24,0) =PV($0$21,825. =PV{$0$21,026, =PV($0$21,027,0,- =UM(023:027) 1.016 jo.1062 ‘Scanned with CamSeannerEXCEL APPLICATION: S IN FINANCING DECISIONS |,cosT OF CAPITAL oem 1: A TY ae prea 12% debentures of & 100 each. The debentures are redeemable sper the expiry of fixed period of 7 years. The company isin 35% tax bracket. Required: {i) Calculate the cost of debt after tax, if debentures are issued at: (a) Par (b) 10% Disccount (c) 10% Premium (ii) If brokerage is paid at 2%, what will be the cost of debentures, if issue is at par? Solution: ((@) When debentures are issued at par: ky =1(1-t) Steps: (i) Enter the given information on the excel sheet (i) Thus, cost of debentures is determined as per the above formula: Home Insert Pagelsyout Formulas «= Dataview = View ___ uM TOR he ME) LA B c i od €E Fo 1 2 SotuTION 3 : Lx ]Debentures @ Rs ~ 100 1000000 Tax : No. of debentures ee.) as | }Debentures issued at par 7.80% um or when brokerage is paid : "ula when debentures are issued at discount/prem! + _NPYN 1(1-t) + RV —NPYN ky = — (RV + NP)2 ‘Scanned with CamSeannerFinancial Managemen, suM a + 1 2 SOLUTION a Debentures 4 2K @RE 100] 1000000 Tax No. of 5 debentures 10000 6 1) debentures 7 Issued at par 8 ° 780% 78% ~L cas a2 (a-capniceeray/My/cave12)/2] on% ilarly, When Debentures are issued at 10% premium and when Brokerage of 2% is paid: = o Fe ARE TGA ATO EDO TINE. 5 omnes) oom Met pee ~ saara-csaiceriaymmucasenaya) oom Net pe 110 suariceyaicecsoymicastiey) coe i Debentures inves Problem 2: Keenam Ltd. is planning to raise 1 crore by the issue of 12% perference share of€ 10? each at 10% discount. The underwriting expenses are expected tobe 2%, Find out the cost of prefere™™ share capital in each of the following cases: (@ If preference share are irredeemable ‘Scanned with CamSeannerxcol Applications in Financing Decisions = | ference share are qo Iepre redeemableat the end of 10 year at 15% premium. Use shortcut method. N 1, Prepare the excel sheet by entering the given informatica 2, To determine the cost of irredeemable preference shares, we use the above formula: solution: () If preference share are irredeemable: k, « a pte nh econ = ne semen E woe a i kes ptt ere rezone Lop fs rte ded a H mares ft Cotten aes lees H Ut preterence share ae redeemable atthe hen ‘end of 10h yeaa 39% premium ls Preference dividend frases. w sinc) i fe renin ons is onto preference shares fe | (i) Ifpreference share are redeemable at the end of 10" year at 15% premium: k, pee ———— | os Fe] (CASH FAS-C13)/20)/(FASCAIY/2) i a [Eaeme aaa = F pais B.-L { 2 sowmon: }- ef t 4 | |3 12% preference share 100 each @ 110000000, { s discount rate 10% [op underwriting expenses 2% t Mf preference share are $4 rmonatie - Preference dividend a a Net Price a 2 Cost of prefernce shares 13.64% 2 Itpreference share are i redeemable at the end of 10th 1s ” year at 15% premium 2 w 25 Preference dividend in v premium a 70.18% Cost of preference shares ‘Scanned with CamScannerS Financial Managemen uoted in the market at 20.00 currently. The company pays, Problem 3: Your company’s share is q pany v's market expects a growth rate5 per cent per year. You ae dividend of ® 1 per share and the invest required tocompute: (i) The company’s equity cost of capital (ii) If the company’s cost of capital is 8 per per annum, calculate market price if the cent and the auticipated growth rate is 5 per cent dividend of % 1 is to be maintained. Solution: Steps: 1. Prepare the excel sheet by entering the given information 2» Cost of equity capital (k,) is found by the following formula: 7 +8 [D, =D, +9)] D, 3. We compute the market price of the share as : P) = 7—y 4. Therefore, the cost of equity and market price of equity shares is found out as follows: Pe vO fe | 10.25% f B 1 SOLUTION : 2 3. Marketvalueofshares 200 4. Dividend at Rs : oa [5 | 6 Growth 005 - 7 8 9. Dividend =C4*(1486) 10! |11 i) Cost of equity =(89/83)+86 2 B 14 ii) Cost of capital 0.08 5 Dividend 16 17 Market price of share =C15/(C14-B6) +33.3333333333333 12 ‘Scanned with CamSeannernel Applications in Financing Decisions , WEIGHTED AVERAGE COST OF Caprray problem 4: limited company has the following apa sauity sare capital (2,00,000shares) 4000009 groPreference share capital z 0.00 ous shDebentares ® 30,00,000 ‘The market price of the company’s equity share i s ‘I is 720, Itis r dividend of @ per share. Itwill grow at 7% forever. The patch expected that company will pay current tocompute the following: ty be presumed at 50%, Youare required 31 @) Aweighted average cost of capital based on existing capital struct re. (i) eee intense ‘capital if the ‘company raises an additional % 20,00,000 debt ‘by 5 es, This would result in increasin, ividend to e ig the expected divid the growth rate unchanged but the Price of share will fall to = 7 per pie aaa | Solution: 1. Prepare the excel sheet by entering the given information [ 8 xi a 1 SOLUTION 2 OLD Equity Share Capital 3 @Rs20 |4000000) 6% Prefernce share 4_capital @Rs 100 1000000) a Corporate = 5 8% Debentures '3000000] Taxrate 50% 6 7 Prices ] ‘Equity [crowth | 8 Equity shares 20 Dividend| ajrate 7% s, prepare the following schedule (Book 2. To calculate the WACC as per the Book Value Basis Specific costs, and composite costs) value (given), weights (as calculated in column oO, Calculation of specific costs of capital (Column D): Cost of Equity (k) = Bt+ g = 2+007% = 0.10 + 0.07 = 0.17 or 17% % 6% (given) = £) = 8% (1-0.50) = 4%, Multiply weights * specific Costs Cost of Preference share (k;) Cost of 8% debentures (k,) = k; (1 To calculate Composite Costs (Column E): Scanned with ComScanner‘Scanned with CamSeanner‘Scanned with CamSeanner‘Scanned with CamSeannerLa Financial Managemen 36 3. To determine the WACC as per the market value approach, prepare the following schedule; specific coststx) [composite Corts source of capital Maret Valve __|Weights(W) (rom coitA26) [Equity Share Capital [4811°40000)"4/S__|=H18/SHS23 [-c2s [18°18 1 sax Pretemce snarecapiea!__|=812*3000 anagysus2a_|acas eustns Retained earning faaisrso00gp 7s [2n20/sHsaa__|aca7 =20"120 12.5% Debentures 81378000 ana/sus23 [aca azia1 [326 Term Loan =38 ana/sus23_—_[-c29 a272 =suqpen2a) [suming To determine the market value of each source of capital: Market value of Equity share capital: P,* No. of equity shares (Note: it is assumed that total market value of equity shares (64.25*40,000) has been divided into equity shares and retained earnings in the ratio of their book values i.e. 4:1) Specific costs for each source of capital have been taken as per the book value method. Se) =Sum(xis:k22) 1) ae = Corporate Tarte 30% +s Growhie OS uit Divide 3 F 12 retemce shares 0) t 13 Debeonwees = =r IWACC using Mack Value > eect specie cos] Gg look {trom cel Composite mares cal 37 Source of capital vatve_|weigtstwn|azc) __|constw'r)_||sourcectcapita __|value 38 (EquityShareCapica! [00000] 0.2] a#075| 3.63%] [EauitySnare copiat | 2ose06o] 0.514 fit Prefemcesnare 119 16% Fretemcesharecapts!| 300000] 0.15] 20.00%] 2.008] leapitat 270000 [20 Revained earring 100000] 0.05] 18.07% 0.90%] [Retained ening | 514000] [21 [12.5% Debentures eoo00o] 0.4 9.218] 3.685] [12 sie Debentures | 7e0000] [22 [126 Termtcan ‘oc000] 0.2[ 8.405] 1.688 [126 Teemtoan 00009 26006 a] 280%) 200000) [a= specine Coss iK) - = ]2s cost oftquty Capital 18.07% Cost of prafeence share capital 20.00% Retained Earnings (wer = aan Costof Debentures 9218 840%,sin Financing Decisions 24 5 16 10,000 80,000 ii) Earning per share (iv) operating Scanned with ComScanner‘Scanned with CamSeannerin Financing Decisions sheet of shaw and co, is as follows: Fixed Assets Curent assets 3, its fixed operating costs are € 1,00,000 and its Tate is 50%, Calculate for the company different Scanned with ComScanner‘Scanned with CamSeanner‘Scanned with CamScanner18 cCostof| eS 15 Market Valve of (Market value of Debt 21 Total Value of Firm [=SUNfaIo: lo |-sumi 3. Compute EBIT, Interest, Tax, Cost of Equity, Market value of equity and Market: the Total value of firm (sum of value of equity and value of debt) from the given: e2a - ae =SUM(819:820) 2 ey cs, ‘Scanned with CamSeannerre es are identical to each otherex E el 3 that S Lid. has debt of €4,00,000 atthe Seeties Debt Ani capital structure, The total amets of both the company ‘company earns 20%, Find the following if bth the companies are in of the companies using NI approach assuming k, as 15%. approach taking k, of R. Ltd. (Unlevered firm) as 15%. ‘Scanned with CamSeannera Using the above, we ge 1300000] 132000] “468009| 387200] 7280800] 15% 7872000] 2000000] 400009] | 2272000] 2000000] 13.20% 15% 23 I f +24 8) Calculation of Value of firm as per NO! Approach (MM Approach with taxes) va of Vleveed em ta) [BOOS55H [2s va of tevered (St 22160000 5. CALCULATION OF EPS Problem company has EBIT of % 4,80,000 and its capital structure Equity share capital (€ 10 each) Be phenctans san, 14.5% debentures es an r, 10,00,000 rs Te ‘company is facing fluctuation in its sales, Tax rate is 35%. What would be th (a) EBIT of the company increased by 25% and (b) EBIT of the company decreased by 25% Solution: Steps: 1. To determine the EPS as per the three information inthe excel sheet as follow” PFePate the schedule as ‘Scanned with CamSeanner| pectt Applications in Financing Decisions ay faasrcs: [so 013 sesaro1s Froie- 015 Fosas7scs7 e 1 acis/cz0 in the formula (Eg. Tax) illustrated in the previous examples. Note: Freeze the cell wherever it is used again 2, Calculate the earnings after tax in the same manner as 3, Find out the earnings available to equity shareholders by subtracting the preference dividend ‘Lailable to equity shareholders by the no of equity shares and EPS by dividing the earnings Scanned with ComScannerFinancial Managemen 46 Problem 12: =, (a) Calculate financial B.E-P from the following: an Interest pa £ 00m Preference dividend Tax rate eal ing » 000. It is expected that lant b) ABC Ltd, has decided to set up a plant costing ~ 10,00,0¢ plant wit) (b) generate operating profits at the rate of 20%. The following four plans have been shortlisted to raise the required funds. (i) Issue of 1,00,000 equity shares of € 10 each. ; z (ii) Issue of 12% preference share ital of € 3,00,000 and equity share capital of % 7,00,000 as in () above. ae (iif) 10% Debt of € 4,00,000 and equity share capital of @ 6,00,000 as in (i) above. (io) Issue of 12% preference share capital of 2,00,000, 10% debt of % 3,00,000 and issue of equity share capital as in (f) above. Find out the EPS in all these situations, given that the tax rate applicable to the 40%. Which option should be prefered by the company. oa Solution: Steps: 1. Prepare the excel sheet $ 2. The financial breakeven level of EBIT is determined by the following formula: cal = Interest char; 2); " i. ges (2 ; Where, PD = Preference dividend os Equly shares (ins) Equity Shares (ns) 10% Debt (in Rs) ‘Scanned with CamSeannerications in Financing Decisions / 224/826 ‘cost of Pant 1000000 Operating Profits 02 equity Shares(in Rs) —-So0000 Ww 4 geass [ao%011, ess-c19 ze20°sa56 [seoe [aoe pene — so000 [ovens ‘Scanned with CamSeannereIEUEUEIE] BEC" E Be Scanned with ComScannerin Financing Decisions o the above problem is.as follows: ‘Scanned with CamSeanner