Subject:- Corporate Finance

Course Name:- Executive Post Graduate Diploma in Management

Name:- Waseeq Ahmed, PR No. 210101618051
Ref:- EPG43/AUGUST21/1076
Email:-awaseeqepgdms21@bus.alliance.edu.in
43rd Batch

Problem 1:- Mahesh Electronics Company Ltd. is considering the purchase of a machine. Two machines P
and Q each costing Rs.50,000 is available. In comparing the profitability of these machines a
I discount rate of 10% is to be used. Earnings after taxes are expected to be as follows:
Year Project 1 Project 2
1 15,000 5,000
2 20,000 15,000
3 25,000 20,000
4 15,000 30,000
5
Evaluate the proposal under: (a) Payback period (b) NPV (c) IRR 10,000 20,000

Answer:-
A. Payback Period:-

Payback back period is a method where it is ascertained that the number of years it takes for an investment to be recouped.
Advantages of payback period:-
(a) It is easy to understand
(b) The calculation and logic are easy to convey to all decision markers
(c) The method gives the decision makers a feeling of comfort that the risk taken is not very heavy.
Disadvantages of payback period:-
(a) It does not consider the time value of money
(b) Inflow received after one year or after four years are treated on an equal platform
(c) Inflows received after paybacks are not considered

Project 1

Year Cumulative PV of
PV of earnings after taxes
Earnings after taxes Rs. PVIF @ 10% Rs. Earnings after taxes
Rs.
1 15,000 0.9091 13,636.50 13,636.50
2 20,000 0.8264 16,528.00 30,164.50
3 25,000 0.7513 18,782.50 48,947.00
4 15,000 0.6830 10,245.00 59,192.00
5 10,000 0.6209 6,209.00 65,401.00

As the PBP falls between 3 rd & 4th Year, below is the calculation to arrive at the PBP of project 1 1,053.00
Payback period calculation 3 Years+(12/10245)*1053 1.23
PBP of project 1 is 3 Years and 1.23 months
Project 2

Year Cumulative PV of
PV of earnings after taxes
Earnings after taxes Rs. PVIF @ 10% Rs. Earnings after taxes
Rs.
1 5,000 0.9091 4,545.50 4,545.50
2 15,000 0.8264 12,396.00 16,941.50
3 20,000 0.7513 15,026.00 31,967.50
4 30,000 0.6830 20,490.00 52,457.50
5 20,000 0.6209 12,418.00 64,875.50

As the PBP falls between 3 rd & 4th Year, below is the calculation to arrive at the PBP of project 2 18,032.50
Payback period calculation 3 Years+(12/20490)*18032.50 10.56
PBP of project 1 is 3 Years and 10.56 months
Payback period of project 1 is better

B. Net Present Value(NPV):-

Net present value (NPV) is the difference between the present value of cash inflows and the present value
of cash outflows over a period of time. NPV is used in capital budgeting and investment planning to analyze
the profitability of a projected investment or project
Formula of NPV is, NPV= Rt/(1+i)t
NPV= Net Present Value
Rt= Net cash flow at time
i= Discount rate
t= time of the cash flow

Project 1
Year Earnings after taxes Rs. PVIF @ 10% Total PV Rs.
1 15,000 0.9091 13,636.50
2 20,000 0.8264 16,528.00
3 25,000 0.7513 18,782.50
4 15,000 0.6830 10,245.00
5 10,000 0.6209 6,209.00
Total 85,000 65,401.00
Initial Investment (50,000.00)
NPV of project 1 15,401.00
Project 2
Year Earnings after taxes Rs. PVIF @ 10% Total PV Rs.
1 5,000 0.9091 4,545.50
2 15,000 0.8264 12,396.00
3 20,000 0.7513 15,026.00
4 30,000 0.6830 20,490.00
5 20,000 0.6209 12,418.00
Total 90,000 64,875.50
Initial Investment (50,000.00)
NPV of project 2 14,875.50
NPV of project 1 is Better

C. Internal rate of return(IRR):-

The internal rate of return (IRR) is a metric used in financial analysis to estimate the profitability of potential investments. IRR is a discount rate that
makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis.IRR calculations rely on the same formula as NPV
does. Keep in mind that IRR is not the actual dollar value of the project. It is the annual return that makes the NPV equal to zero.

Project 1
PV Earnings after
Year Earnings after taxes Rs. PVIF @ 10% PV Earnings after taxes Rs. taxes Rs.
1 15,000 0.9091 13,636.50
2 20,000 0.8264 16,528.00 PV of CIF's - PV of
3 25,000 0.7513 18,782.50 COF's
4 15,000 0.6830 10,245.00 65,401-50,000
NPV=15,401
5 10,000 0.6209 6,209.00
PV I,n = 85,000 65,401.00

Project 2
PV Earnings after
Year Earnings after taxes Rs. PVIF @ 10% PV Earnings after taxes Rs. taxes Rs.
1 5,000 0.9091 4,545.50
2 15,000 0.8264 12,396.00 PV of CIF's - PV of
3 20,000 0.7513 15,026.00 COF's
4 30,000 0.6830 20,490.00 64,875.50-50,000
NPV=14,875.50
5 20,000 0.6209 12,418.00
PV I,n = 90,000 64,875.50
Computation of IRR- trail and error method
Project 1
PV Earnings after
Year Earnings after taxes Rs. PVIF @ 20% PV Earnings after taxes Rs. taxes Rs.
1 15,000 0.8333 12,499.50
2 20,000 0.6944 13,888.00 PV of CIF's - PV of
3 25,000 0.5787 14,467.50 COF's
4 15,000 0.4823 7,234.50 58,152.50-50,000
NPV=2,108.50
5 10,000 0.4019 4,019.00
PV I,n = 85,000 52,108.50
PV Earnings after
Year Earnings after taxes Rs. PVIF @ 24% PV Earnings after taxes Rs.
taxes Rs.
1 15,000 0.8065 12,097.50
PV of CIF's - PV of
COF's
47,974-50,000
NPV=-2,026
 2 20,000 0.6504 13,008.00 PV of CIF's - PV of
3 25,000 0.5245 13,112.50 COF's
4 15,000 0.423 6,345.00 47,974-50,000
NPV=-2,026
5 10,000 0.3411 3,411.00
PV I,n = 85,000 47,974.00
IRR @ 20% 52,108.50
IRR @ 24% 47,974.00
Difference 4,134.50
IRR of project 1= 20%+ (0.04/4134.5*2108.5) 0.02 22.04%
Computation of IRR- trail and error method
Project 2
PV Earnings after
Year Earnings after taxes Rs. PVIF @ 16% PV Earnings after taxes Rs. taxes Rs.
1 5,000 0.8621 4,310.50
2 15,000 0.7432 11,148.00 PV of CIF's - PV of
3 20,000 0.6407 12,814.00 COF's
4 30,000 0.5523 16,569.00 54,363.50-50,000
NPV=4,363.50
5 20,000 0.4761 9,522.00
PV I,n = 90,000 54,363.50
PV Earnings after
Year Earnings after taxes Rs. PVIF @ 20% PV Earnings after taxes Rs.
taxes Rs.
1 5,000 0.8333 4,166.50
2 15,000 0.6944 10,416.00 PV of CIF's - PV of
3 20,000 0.5787 11,574.00 COF's
4 30,000 0.4823 14,469.00 48,663.50-50,000
NPV=-1,336.50
5 20,000 0.4019 8,038.00
PV I,n = 90,000 48,663.50
IRR @ 20% 54,363.50
IRR @ 24% 48,663.50
Difference 5,700.00
IRR of project 1= 16%+ (0.04/5700*4363.50) 0.03 19.06%
IRR of project 1 is Better
Conclusion:- Since PBP & NPV of project 1 is better, hence project 1 to be preferred

Problem 4: -
II A firm whose cost of capital is 10% is considering two projects X and Y, the details of which are:
Particulars Project X in Rs. Project Y in Rs.
Investment 100,000 100,000
Cash inflows: 1st Year 20,000 45,000
2nd Year 30,000 40,000
3rd Year 40,000 30,000
4th Year 50,000 10,000
5th Year 60,000 8,000
Total Cash Inflow 200,000 133,000
Compare the net present value at 10%, profitability index, and internal rate of return for the two projects separately.
Answer:-
A. Net Present Value(NPV):-
Project X
Year PVIF @ 10% Cash Inflows Rs. PV of cash inflows Rs.
Investment - (100,000) -
1 0.9091 20,000 18,182.00
2 0.8264 30,000 24,792.00
3 0.7513 40,000 30,052.00
4 0.6830 50,000 34,150.00
5 0.6209 60,000 37,254.00
Total - 200,000 144,430
NPV= PV of cash inflows - PV of cash outflow 44,430
Project Y
Year PVIF @ 10% Cash Inflows Rs. PV of cash inflows Rs.
Investment - (100,000) -
1 0.9091 45,000 40,909.50
2 0.8264 40,000 33,056.00
3 0.7513 30,000 22,539.00
4 0.6830 10,000 6,830.00
5 0.6209 8,000 4,967.20
Total - 133,000 108,302
NPV= PV of cash inflows - PV of cash outflow 8,302
NPV of project X is Better
B. Profitability index(PI):-

Profitability index shows the relationship between company projects future cash flows and initial investment by calculating the ratio and analyzing the
project viability and it is calculated by one plus dividing the present value of cash flows by present value of cash outflow and it is also known as profit
investment ratio as it analyses the profit of the project
Project X
Year PVIF @ 10% Cash Inflows Rs. PV of cash inflows Rs.
Investment - (100,000) -
1 0.9091 20,000 18,182.00
2 0.8264 30,000 24,792.00
3 0.7513 40,000 30,052.00
4 0.6830 50,000 34,150.00
5 0.6209 60,000 37,254.00
Total - 200,000 144,430
PI= PV of cash inflow/ PV of Cash outflow 1,44,430/1,00,000 1.44
Project Y
Year PVIF @ 10% Cash Inflows Rs. PV of cash inflows Rs.
Investment - (100,000) -
1 0.9091 45,000 40,909.50
2 0.8264 40,000 33,056.00
3 0.7513 30,000 22,539.00
4 0.6830 10,000 6,830.00
5 0.6209 8,000 4,967.20
Total - 133,000 108,302
PI= PV of cash inflow/ PV of Cash outflow 1,08,302/1,00,000 1.08
Profitability index of project X is Better
C. Internal rate of return (IRR):-
Project X- IRR @ trail and error method
Year PVIF @ 20% Cash Inflows Rs. PV of cash inflows Rs.
1 0.8333 20,000 16,666.00
2 0.6944 30,000 20,832.00 PV of CIF's - PV of
3 0.5787 40,000 23,148.00 COF's 1,08,875-
4 0.4823 50,000 24,115.00 1,00,000 NPV=8,875
5 0.4019 60,000 24,114.00
Total - 200,000 108,875
Year PVIF @ 24% Cash Inflows Rs. PV of cash inflows Rs.
1 0.8065 20,000 16,130.00
2 0.6504 30,000 19,512.00 PV of CIF's - PV of
COF's 98,238-
3 0.5245 40,000 20,980.00 1,00,000 NPV= -
4 0.4230 50,000 21,150.00 1,762
5 0.3411 60,000 20,466.00
Total - 200,000 98,238
IRR @ 20% 108,875.00
IRR @ 24% 98,238.00
Difference 10,637.00
IRR of project X= 20%+ (0.04/10,637*8,875) 0.03 23.34%
Project Y- IRR @ trail and error method
Year PVIF @ 12% Cash Inflows Rs. PV of cash inflows Rs.
1 0.8929 45,000 40,180.50
2 0.7972 40,000 31,888.00 PV of CIF's - PV of
3 0.7118 30,000 21,354.00 COF's 1,04,317-
4 0.6355 10,000 6,355.00 1,00,000 NPV=4,317
5 0.5674 8,000 4,539.20
Total - 133,000 104,317
Year PVIF @ 14% Cash Inflows Rs. PV of cash inflows Rs.
1 0.8772 45,000 39,474.00
2 0.7695 40,000 30,780.00 PV of CIF's - PV of
3 0.6750 30,000 20,250.00 COF's 1,00,580-
4 0.5921 10,000 5,921.00 1,00,000 NPV=580
5 0.5194 8,000 4,155.20
Total - 133,000 100,580
IRR @ 12% 104,316.70
IRR @ 14% 100,580.20
Difference 3,736.50
IRR of project Y= 12%+ (0.02/3,736.50*4,317) 0.02 14.31%

Conclusion:- Since IRR, of project Y is lower and even NPV of project Y is higher in first two years, hemce project Y can be preferred
 Problem 6: -
III Operating profits (EBIT) of a company is amounted to Rs.4,80,000. Its capital structure consists of the following securities:
10% debentures Rs.15,00,000
12% Preference shares Rs.3,00,000
Equity Shares of Rs.100 each Rs.12,00,000
The company is in the 55% tax bracket (a) Determine the company’s EPS b) Determine the
percentage change in EPS associated with 30% increase and 30% decrease in EBIT.

Answer:-
EBIT @ 30%
EBIT EBIT @ 30% increase
Particulars decrease
Rs. Rs.
Rs.
EBIT 480,000 624,000 336,000
(-) Interest (150,000) (150,000) (150,000)
Earnings before tax (EBT)= (EBIT-Interest) 330,000 474,000 186,000
(-) Tax @ 55% (181,500) (260,700) (102,300)
Profit after tax (PAT)= (EBT-Tax) 148,500 213,300 83,700
(-) Preference dividend on dividend share (300000*12%) (36,000) (36,000) (36,000)
Profit available for equity shareholders 112,500 177,300 47,700
No. of equity shares= (12,00,000/100) 12,000 12,000 12,000
EPS (Profit available for equity shareholders/No. of shares) 9.38 14.78 3.98

Change in EPS due to 30% increase in EBIT= (New EPS-Old EPS)/Old EPS*100 (14.78-9.38)/9.38*100 57.60 -

Change in EPS due to 30% decrease in EBIT= (New EPS-Old EPS)/Old EPS*100 (3.98-9.38)/9.38*100 - (57.60)

Problem 2: - Solve the following:

IV a. What will a deposit of Rs.4,500 at 7% annual interest is worth if left in the bank for nine years?
b. Given an annual opportunity cost of 10%, what is the future value of a Rs.1,000 ordinary annuity for 10 years?
c. What is the present value of Rs.800 to be received at the end of 8 years, assuming an interest rate of 20 percent, quarterly compounding?
d. Your mother is planning to retire this year. Her firm has offered her a lump sum retirement payment of Rs.50,000 or a Rs.6,000 lifetime ordinary
annuity-whichever she chooses. Your mother is in reasonably good health and expects to live for at least 15 more years. Which option should she
choose, assuming that an 8 percent annual interest rate is appropriate to evaluate the annuity?
Answer:-
Answer to question- (a)
Formula to calculate interest for 9 years FV i, n = P x FVIF i, n
Details available in question= P= Rs. 4500, annual interest @ 7% and for 9 years
Rs. 4500 x FVIF 7%, 9 yrs = Rs. 4500x1.8385
Total Amount for 9 years= 8,273.25
Total Amount for 9 years= Principal + Interest
Interest= Total Amount for 9 years - Principal
Interest= 3,773.25
Answer to question- (b)
FV= (1+r)^n-1/r*Payment amount
Payment amount= Rs. 1000
r= 10%
n= 10 years
FV= (1+0.1)^10-1)/10*1000 15.937
FV= 15,937
Answer to question- (c)
Interest rate is 20% which is quarterly compounded= 5%
8 Years compunded means= 8*4=32
FV= PV*(1+i)^n FV= Rs. 800*(1+.05)^32
FV= Rs. 800*(1.05)^32
PV= Rs. 800*0.2099 167.92
PV= 167.92
Answer to question- (d)
PV of annuity flow = p{1-(1+r)^-n/r}
P= Periodic payment Rs. 6000
r= rate per period 8%
n= number of periods 15 years
PV of annuity value for 8 years @ 15% = 8.5595
PV of annuity value for 8 years for Rs. 6000= 51,357.00
Because the lifetime annuity has a higher expected present value than the Rs.50,000 lump sum payment, she should take the annuity.