Project Appraisal

Techniques
Modern and Traditional Methods
Methods of Economic Analysis/ Project Appraisal
I. Modern methods ( Discounted Cash flows) - Time Value - Interest rate
A. Net Present Value Method
B. Internal Rate of Return Method
C. B/C ratio Method
D. Discounted payback

II. Traditional methods ( Non - discounted cash flows)

● Payback period
● Accounting rate of return
Modern Methods
1. Net Present Value

PV T (0)______________________________________________ ___T(n) FV
1 2 3 4 5 6 Time
Net Present Value
NPV

NPV@ OC = CF 0 + CF 1 (1 + OC/100)-1 + CF 2 (1 + OC/100)-2 + CF 3 (1 + OC/100)-3

+ ------------- + CFn (1 + OC/100)-n

Decision criteria
If , NPV is > Zero, Accept project.
Else - reject the project as it is not beneficial.
 2. IRR , NPV = 0
IRR formula
IRR = LD + ( NPV@ LD ) x (HD - LD)
__________________
( NPV@ LD ) - ( NPV@ HD )
Where,
LD = Lower discount rate, NPV is going to be positive
HD = Higher discount rate , NPV is going to be negative.
NPV = Net present value

IRR = where, NPV is made equal to ‘zero’.

Decision criteria

IRR > ‘OC” - Accept else reject

IRR > MARR - Accept

3. Benefit - Cost ratio, Profitability Index
B/C Ratio

∑ DCF benefits
___________ X 100
∑ DCF Costs

Decision criteria

If B/C ratio > 1, select the project, if not reject.

Net Present Value/ IRR - Problem
Mr. Avinash is planning to start a venture, which requires an initial investment of
Rs. 25 lakhs. The expected life span of the project is 3 years with a salvage value
of Rs. 3 lakhs. The expected net cash flows are going to start at the end of 1st
year which is Rs.8 lakhs with an increment of Rs. 1.5 lakhs every year. The
opportunity cost of capital is 12%. Assume do-nothing analysis and suggest
whether venture is beneficial or not based on net present value.
NPV - Problem- at T (0) interval time - Contd
Table showing Data given in the problem and process to calculate NPV

TIME (1) Cash flow (2) Discounting Process (3) Discounted cash flow (2X3)

T (0) -25 lakhs ------------ (1) - 25 lakhs

T (1) 8 lakhs
-1
( 1+12/100)

T (2) 9.5 lakhs

( 1.12)-2

T (3) 11 +3 lakhs
( 1.12)-3
Solution
Calculation

NPV @12 % = - 25 lakhs + Rs. 8,00,000( 1.12)-1 + Rs.9, 50,000( 1.12)-2 + Rs.14,00,000( 1.12)-3

NPV @12 % = - 25 lakhs + Rs. 7,14,285 + Rs.7,57,334 + Rs. 9,96,492

= Rs. - 31,889

Decision criteria

NPV @ 12 % < ‘Zero’

Hence the venture is not beneficial based on NPV. Economically not beneficial.
NPV - Problem- at T (0) interval time - Contd
Table showing Data given in the problem and process to calculate NPV

TIME (1) Cash flow (2) Discounting Process (3) Discounted cash flow (2X3)

T (0) -25 lakhs ------------ (1) - 25 lakhs

T (1) 8 lakhs 7,27,272

-1
( 1+10/100)

T (2) 9.5 lakhs 7,85,123

-2
( 1.10)

T (3) 11 +3 lakhs 1051840

-3
( 1.10)
Solution
Calculation

NPV @10 % = - 25 lakhs + Rs. 8,00,000( 1.10)-1 + Rs.9, 50,000( 1.10)-2 + Rs.14,00,000( 1.10)-3

NPV @10 % = Rs. 64235.

Decision criteria

NPV @ 12 % < ‘Zero’

Hence the venture is not beneficial based on NPV. Economically not beneficial/viable

NPV @ 10% > Zero, Economically beneficial/viable, Accept

IRR - Basic calculation ( NPV @ HD and LD)
NPV @12 % = - 25 lakhs + Rs. 8,00,000( 1.12)-1 + Rs.9, 50,000( 1.12)-2 + Rs.14,00,000( 1.12)-3

NPV @ 12% = Rs. - 31,889

NPV @10 % = - 25 lakhs + Rs. 8,00,000( 1.10)-1 + Rs.9, 50,000( 1.10)-2 + Rs.14,00,000( 1.10)-3

NPV @ 10 % = Rs. 64,235

 LD + ( NPV@ LD ) x (HD - LD)

IRR __________________
( NPV@ LD ) - ( NPV@ HD )
Where,
LD = 10%, = Rs. 64235
IRR HD = 12% = Rs. - 31,889

IRR = 11.34%

Decision Criteria.
IRR < OC, Not economically viable, Reject