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Illustration 4: (Certainty Coefficient)
From the following data of Shatabdi Ltd., find out which project is better using Certain~
. tA,pproach.
Coe ffi cIen
Year Project K Project L
CFAT (Rs.) Certainty Equivalent CFAT (Rs.) Certainty Equivalent
Coefficient Coefficient
1 60,000 0.9 50,000 0.8
2 ' 50,000 0.8 60,000 0.7
3 20,000 0.6 30,000 0.5
4 50,000 0.5 20,000 0.4
Each of the proiects requires a cash outlay of Rs. 1,00,000. Risk free discount rate is 12%for
both the projects.
 ·tal Budgeting
CaPI 97

Solution: proIect
. K
Cash Inflow CE Coefficient Adjusted CF
Year PVF @12% DCF (Rs.)
{Rs.) (Rs.)
60,000 0.9
~ 54,000 0.893 48,222
2 50,000 0.8 40,000 0.797 31,880
3 20,000 0.6 12,000 0.712 8,544
4 50,000 0.5 25,000 0.636 15,900
:E PV of Cash Inflow 1,04,546
Less: Original lnvestrrent 1,00,000
,---
NPV 4,546
Pro ect L
Year Cash Inflow CE Coefficient Adjusted CF PVF @12% DCF {Rs.)
Rs. Rs.
1 50,000 0.8 40,000 0.893 35,720
2 60,000 0.7 42,000 0.797 33,474
3 30,000 0.5 15,000 0.712 10,680
4 20,000 0.4 8,000 0.636 5,088
:E PV of Cash Inflow 84,962
Less: Original lnvestrrent I - - - - -1,00,000
'----'---~
NPV 15,038
Summary:
Project NPV (Rs.)
K 4,546
L (15,038)
/Ans.: Project Kisto be selected as the NPV is positive.
~ r']llustration 5: (Certainty Equivalent)
~ A project costing Rs . 1,00,000 has the following estimated cash flows and certainty equivalent
coefficients as follows:
Year 1 2 3 4
Cash Inflow (Rs.) 70,000 80,000 50,000 60,000
CE Coefficient 0.8 0.6 0.7 0.67
If the risk free discount rate is 10%, calculate its NPV.
Solution·.
Year NCF (Rs.) CE Coiefficient Adjusted NCF PV @10% PV of CF (Rs.)
(Rs.)
1 70,000 0.8 56,000 0.909 50,904
2 80,000 0.6 48,000 0.826 39,648
3 50,000 0.7 35,000 0.751 26,285
- 4 60,000 0.67 40,200 0.683
L Present Value
27,457
1,44,294
Less: Investment 1,00,000

- Ans.: NPV is Rs. 44,294.

111,.~L. , • .
Net Present Value 44,294
 ·case.
s,PCQnd year end disGount factor nas to oe usec!"in tnii
/ illustration 7: (Sensitivity Analysis)
'\A.~ · A company has two mutually exclusive projects. e management has developed the following
.-- estimates of the annual cash flows for each ro·ect havin a life of 10 ears and 12% discount rate.
,,. Pro·ect X Rs. Pro·ect Y Rs.
Net Investment 1,00,000 1,00,000
Annual CFAT:
Pessimistic 12,000 15,000
Most Likely 17,000 17,000
O timistic 20,000 19,000
Calculate NPV using Sensitivity Analysis. Comment.
Solution:
. tX
Pro1ec
Situations Annual CFAT PVAF@ 12%; PVof CFAT Investment NPV (Rs.)
(Rs.) 10 years (Rs.) (Rs.)
Pessimistic 12,000 5.650 67,800 1,00,000 {32,200)
i Expected 17,000 5.650 96,050 1,00,000 (3,950)
I Optir.iistic 20,000 5.650 1,13,000 1,00,000 13,000
. ty
pro1ec
PVAF@ 12%; PV of CFAT Investment
I Situations Annual CFAT
10 years (Rs.) (Rs.)
NPV (Rs.)
(Rs.)
Pessimistic 15,000 5.650 84,750 1,00,000 (15,250)
ExpectAd "17,000 5.650 96,050 1,00,000 (3,950)
Optimistic 19,000 5.650 1,07,350 I 1,00,000 7,350
Project X is more riskier than Project Y due to wide fluctuations in the NPV in case of
eroie_cJ--X.
 1 LL,OUU u.~ 4,4UU U.~U~ ::S,!::ll:J!::l.bU
2 21,000 0.2 4,200 0.826 3.469.20
3 17,000 0.2 3,400 0.751 2,553.40
4 15,000 0.2 3,000 0.683 2,049.00
5 12,000 0.2 2,400 0.621 I 1,490.40
-
I: PV of Cash Inflow 13,561.40
-
Ans.: Project LA is to be accepted due to higher present value of Cash Inflows.
Illustration 10: (Standard Deviation)
. tA
ProJec
- 10,000 12,000 14,000 16,000
Cash Flows (Rs.) 8,000
Probability 0.10 0.20 0.40 0.20 0.10
 Vipad's™ Strategic Financial Management (B
102 Ms)
Pro·ect B
20 000
000_1_ _ 16,000 12,000 8 oo
ICash Fl?ws {BsJ_ 241 o:15 5 -+-~•~o
0.50 -t--:::o"-:.1::--
[ Probab111ty I. o.1o . . . f . t o.10
Compute Standard Deviation and Comment on nskmess o proJec .
Solution:
· tA
Proiec
CF
- - P1
CF (CF1 CF) (CF1-CF )2 (CF1-CF)2 p1
8,000 12,000 (4,000) 1,60,00,000 0.1 16,00,ooo
10,000 12,000 (2,000) 40,00,000 0.2 8,00,000
12,000 12,000 0 0 0.4 0
14,000 12,000 2,000 40,00,000 0.2 8,00,000
16,000 12,000 4,000 1,60,00,000 0.1 16,00,000 I
60,000 60,000 0 - 1.0 48,00,000]
tCF
CF = N
60,000
= 5
= 12,000
i --C-F)_2_Pi
cr = ✓,-t-(C_F_

= ✓ 48,00,000
cr = 2,190.89
cr = 2,191
. tB
ProJec
CF - - - P1 -
CF (CF1 -CF) (CF1-CF)2 (CF, - CF )2 P1
24,000 16,000 8,000 6,40,00,000 0.1 64,00,000
20,000 16,000 4,000 1,60,00,000 0.15 24,00,000
16,000 16,000 0 0 0.5 0
12,000 16,000 (4,000) 1,60,00,000 0.15 24,00,000
8,000 16,000 (8,000) 6,40,00,000 0.1 64,00,000
80,000 80,000 0 1.0 1,76,00,000
CF = r, iF

80,000
= 5
= 16,000
cr = ✓rt_(_C_F1___C_F_)2-p
1
= ✓ 1,76,00,000
cr = 4,195.23
cr = 4,195
summary:

Inference.
Prolect
A
B
Standard Deviation
2,191
4,195
Remarks
-
Hiqher Risk
----
Since the Standard Deviation is higher In case of p j t 8 h .. • k'ier proi·ect.
ro ec ; ence 1t 1s a more ns