I.

Payback Period

Pay Back Period (PBP) is the period of time required

for the cumulative expected cash flows from an
investment project to equal the initial cash outflow.
Payback Period = a+((b-c)/d)
a = The year in which investment is near to recover
b = initial investment
c = cumulative cash flow of the year in which
investment is near to recover
d = cash flow of the year in which investment is fully
recovered

YTM of the Bond (Cost of debt)

What is the current cost of debt for a firm that has a 9%

coupon bond with 5 years to maturity and a current price of
$962? What is the after tax cost if it is in the 40% tax
bracket?

YTM= Yield to maturity

I = Annual (periodic) Interest Payment
F = Par Value of the Bond
P = Price of the Bond
n= years (time periods) to maturity
Interest Payment = 0.09*1000=90
Capital Budgeting Question (NPV,IRR,PBP and DPBP) YTM = (90+((1000 – 962)/5)) /(0.4*1000+0.6*962)
Suppose you are evaluating a new project for your company F-P=1000-962=38
and you have determined that the after-tax cash flows for
the project will be Rs.10,000, Rs.12,000, Rs.15,000, (F-P)/n=38/5
Rs.10,000, and Rs.7,000 respectively for each of the Years 1
I + (F-P)/n = 90+7.60 = 97.60
through 5. The initial cash outlay will be Rs.40,000.
0.4*1000+0.6*962 =977.2

97.60/977.2 = 0.0998

YTM = 0.0998 = 9.98%

PBP Acceptance Criterion

Suppose your management has set a maximum PBP of 3.5

Years for projects of this type. Should this project be
accepted?

Yes! The firm will receive back the initial cash outlay in less
than 3.5 Years. [3.3 Years < 3.5 Year Max.]
 II. Internal Rate of Return (IRR)

IRR is the discount rate that equates the present value of

the future net cash flows from an investment project with
the project’s initial cash outflow.

ICO = Initial Cash Outflow

Find the interest rate (IRR) that causes the discounted cash
flows to equal Rs.40,000.

IRR Solution (Try at 10%)

IRR Solution (Try at 15%)

III. Net
Present
Value
(NPV)

NPV is the present value

of an investment
project’s net cash flows
minus the project’s initial cash outflow. Sum of present
value of all cash flow

NPV: Sum of the PVs of inflows and outflows.

Suppose you have determined that the appropriate

discount rate (k) for this project is 13%.
 NPV
Acceptance
Criterion

Suppose
your

IRR Acceptance Criteria

Suppose your management has determined that the required rate is 13%
for projects of
this type.
management has Should this
determined that the project be
hurdle rate is 13% for accepted?
projects of this type. Should this
No! The NPV is
project be accepted?
negative. This
No! The firm will receive 11.57% for each rupees invested means that the
in this project at a cost of 13%. [ IRR < Hurdle Rate ] project is
reducing
If IRR > WACC, then the project’s rate of return is greater shareholder
than its cost-- some return is left over to boost wealth. [Reject
stockholders’ returns. as NPV < 0 ]
IRR Approximation Formula

Coupon Bond Price

5 Year annual coupon bond with coupon rate of 12 with

required rate of return of 6%. Find the price and duration of
the Bond. Face Value is the bond is $100.

Expected Returns and Standard Deviation

1. Medicom is a Pharma company

in the New York City. The following table lists the
 stock prices and dividends on Unicom from 2014 to
2023.

a. Estimate the average annual return that you would

have made on your investment.

b. Estimate the standard deviation and variance in the

annual returns.

Return must includes dividend.

Return=[ Pricet - Pt-1 + Dividendperiod ] / Pricet-1

2. Navneet Paper Products is considering expansion

into manufacture of two different paper. The
markets are uncertain and the estimates of Cash
flows for both the projects with corresponding
probabilities are as below:

More risky

Based on the
economic
outlook for the
industry
Emerald Corporation has determined the following three
possible returns
given three
different states of
the economy over
the next period.

A. What is the
expected return
for Emerald
Corporation ?

B. What is the standard deviation for Emerald Corporation ?

Break Even Analysis
Total Variable cost = 30,000 + 5,000
XYZ ltd produces satellite earth stations that sell for
Rs.100000 each. The firm’s fixed costs are Rs.2 million; Its Break Even Quantity = Fixed Cost / (Sale Price per Unit-
material variable cost per unit is Rs.30,000 and labour Variable cost per unit)
variable is cost is Rs. 5,000
BEQ =2,000,000/(100,000-35,000) = 30.7692307692
a. What is the Break Even Quantity?
Break Even Sales = 30.7692307692* 100,000
b. What is the break Even Sales?
= 3076923.07692

Cost of Capital

Radiant Technology has a project costing Rs. 15 crores for

making high-end microchips on hand. It shall provide the
earning level of Rs. 4 crores annually. With a view to decide
the desired capital structure the firm compiled following
data with respect to cost of debt and cost of equity for debt
levels of 20% to 70% of the cost of the project, that is
reproduced below:

Cost of Project = Rs.1500 lacs

Marginal Tax rate = 40%

Note: We are taking the Book Value and not taking the
market Value here

WACC= We*ke + Wd*kd+Wp*kp

We= 0.20

Wd = 0.80
Kd= post tax cost of debt = Pre tax cost of debt *(1-t)
E(R) = 0.25(0.02) + 0.5(0.14) + (0.25)(0.30) = 0.005 + 0.07 +
0.075 = 0.15
Variance = .25*(0.2 – 0.15)2 + 0.5*(0.14 – 0.15)2 + 0.25*(0.3
– 0.15)2 = 0.00631
Standard Deviation = Sqrt(0.00631) = 0.0794 or 7.94%
 
Stanza Private Limited(SPL) has 10 million shares of
common stock outstanding, 2 million shares of 8 percent
preferred outstanding, and 250,000 $1,000 par, 12 percent
semiannual coupon bonds outstanding. The stock sells for
$45 per share and has a beta of 1.6, the preferred stock
sells for $50 per share, and the bonds have 10 years to
maturity and sell for 85 percent of par. The market return as
 proxied by
Nifty50 returns
are 11 percent, T-
bills are yielding 6
percent, and the
firm’s tax rate is
40 percent. What
is SPL’s WACC?

How to solve
this?
3 steps:
1) Calculate the Weights
2) Calculate the returns (Cost of the specific capital)
3) Put everything together in the WACC formula

A) Calculation of Weights

i. Common Equity

# of shares outstanding 10000000

Stock price 45 market price
Market Value 450000000 Market capitalization

ii. Preferred
# of shares outstanding 2000000
Stock price 50 market price
Market Value 100000000

iii. Bond
# of bonds 250000
Par value 1000
Market price 850
Market Value 212500000

Weights
Market Value Weights
w(e) 450000000 59.0%
w(p) 100000000 13.1%
w(d) 212500000 27.9%
Total 762500000
CAPM Model : Expected return = Risk Free Rate + beta
*(Expected Market Return- Risk Free Rate)