ANS

1) Net Present Value

Net Present Value(NPV) is a formula used to determine the present value of an
investment by the discounted sum of all cash flows received from the project. When a
company or investor takes on a project or investment, it is important to calculate an
estimate of how profitable the project or investment will be. In the formula, the -C0 is
the initial investment, which is a negative cash flow showing that money is going out as
opposed to coming in. Considering that the money going out is subtracted from the
discounted sum of cash flows coming in, the net present value would need to be positive
in order to be considered a valuable investment.

Machine A
Machine B

Present Value NPV

12.41
-12.59
13.61
-26.39

Accept the project only if its NPV is positive or zero. Reject the project having negative NPV. While
comparing two or more exclusive projects having positive NPVs, accept the one with highest NPV.

NPV =

R1
(1 + i)1

R2
(1 + i)2

R3
(1 + i)3

+ ... Initial Investment

Decision: Both the machine doesnt give positive NPV, so replacement cant
considered.

2) Profitability Index
Profitability index is an investment appraisal technique calculated by dividing the present value of
future cash flows of a project by the initial investment required for the project. Profitability index is
actually a modification of the net present value method. While present value is an absolute
measure (i.e. it gives as the total Rupee figure for a project), the profitability index is a relative
measure (i.e. it gives as the figure as a ratio).

Decision Rule
Accept a project if the profitability index is greater than 1, stay indifferent if the profitability index
is zero and don't accept a project if the profitability index is below 1.
Profitability index is sometimes called benefit-cost ratio too and is useful in capital rationing since
it helps in ranking projects based on their per dollar return.

Profitability Index

Machine A

0.50

Machine B

0.34

Decision: Both the machine doesnt give greater than one , so replacement cant
considered.

3)

Pay Back Period

The payback period formula is used to determine the length of time it will take to recoup
the initial amount invested on a project or investment. The payback period formula is
used for quick calculations and is generally not considered an end-all for evaluating
whether to invest in a particular situation. One issue is that the payback period formula
does not look at the value of all returns.

Payback
Period
Machine A
Machine B

0.47
0.56

Decision: Shorter payback period for Machine A, so option

available with Machine A.

4) Discounted payback method:

In discounted payback period we have to calculate the present value of each cash inflow taking the
start of the first period as zero point.

Discounted Payback Period = A +

B
C

Where,
A = Last period with a negative discounted cumulative cash flow;
B = Absolute value of discounted cumulative cash flow at the end of the period A;
C = Discounted cash flow during the period after A.

Machine A: 3 Years + -5.842/9.562 =3 yrs +.61 = 3.61

Machine B = 3 years +-7.3186/11.611 = 3 years +.63 = 3.63 Years

Decision Rule
If the discounted payback period is less that the target period, accept the project. Otherwise
reject.
Discounted payback period is more reliable than simple payback period since it accounts for time
value of money. It is interesting to note that if a project has negative net present value it won't
pay back the initial investment.
Since Disocounted payback period is less in the case of Machine A, Machine A can select.
Calculation.

Outflow
Machine A
Machine B

25
40

1
0
10

Present value

0.9091

PV Machine A

PV Machine B

9.091

Cumulative DCF A

-25

-25

Cumulative DCF B
Discounted Payback
A
Discounted Payback
B

-40

-30.909

2
5
14
0.826
4
4.132
11.56
96
20.86
8
19.33
94

3
20
16

4
14
17

0.7513

0.683

15.026
12.020
8

9.562
11.61
1

5
14
15
0.620
9
8.692
6
9.313
5

-5.842

3.72

12.41
26

4.292
4

13.60
59

-7.3186
3 to 4
Years
3 to 4
Years