Managerial Finance Solution - PDF

Managerial Finance

Solution 1:
a. Following is the table representing cash flows from the project:
Yea
r Cash Flows
Add:
Depreciation Net Cash Flow
0 -30,00,000 - -30,00,000
1 7,00,000 2,80,000 9,80,000
2 7,00,000 2,80,000 9,80,000
3 7,00,000 2,80,000 9,80,000
4 7,00,000 2,80,000 9,80,000
5 -13,00,000 2,80,000 -10,20,000
6 7,00,000 6,80,000 13,80,000
7 7,00,000 6,80,000 13,80,000
8 7,00,000 6,80,000 13,80,000
9 7,00,000 6,80,000 13,80,000
10 9,00,000 6,80,000 15,80,000
b. Using the required rate of 10%, the net present value of the project is:
Calculation of Net Present Value
Year Cash
Flows
Add:
Depreciation
Net Cash
Flow
PV factor @
10%
PV of Cash
Flows
0 -30,00,000 - -30,00,000 1.000000 -30,00,000
1 7,00,000 2,80,000 9,80,000 0.909091 8,90,909
2 7,00,000 2,80,000 9,80,000 0.826446 8,09,917
3 7,00,000 2,80,000 9,80,000 0.751315 7,36,289
4 7,00,000 2,80,000 9,80,000 0.683013 6,69,353
5 -13,00,000 2,80,000 -10,20,000 0.620921 -6,33,340
6 7,00,000 6,80,000 13,80,000 0.564474 7,78,974
7 7,00,000 6,80,000 13,80,000 0.513158 7,08,158
8 7,00,000 6,80,000 13,80,000 0.466507 6,43,780
9 7,00,000 6,80,000 13,80,000 0.424098 5,85,255
10 9,00,000 6,80,000 15,80,000 0.385543 6,09,158

Net Present Value(PV of Cash inflows-PV of cash outflow) 27,98,454
Net present value is the difference between the present value of cash inflows and cash
outflows, if the value of cash inflows are more than that of outflows, the project is
expected to create value for the company (Adelaja, 2015). In the given case the net
present value of the project is $2798454. This indicates that the project will earn the
company $2798454 above investment. Therefore, based on NPV evaluation the project
should be accepted.
c. Internal rate of return helps calculate the actual return earned form a project by
equating the cash inflows with the cash outflows (Bierman & Smidt, 2010). If the
internal rate of return is more than the discount rate the project should be accepted. In
the given case we have calculated the IRR of the project and it resulted to be 27%.
The required rate id 10%. Since the IRR is more than required arte the project should
be accepted.
Profitability index is another tool which helps to calculate the return per invested
dollar in a project. If return is more than 1 the project should be accepted. The
profitability index of the project is 1.93 times, this means that the company will earn a
profit of $0.93 on every dollar invested.
Profitability
Index = Present Value of Future Cash Flows
Initial Investment Required
= 57,98,454
30,00,000
= 1.93
d. The payback period calculates an estimated time period within which the investor can
recover the invested amount in a project (Holtzman, 2013). Lower the pay-back
period, better is the investment opportunity. The pay-back period for this project is
3.06 years, and the project period is 10 years. The project sees viable and should be
accepted.
Calculation of Payback Period