Answer 1)

INTRODUCTION:

Sensitivity analysis and scenario analysis are two crucial tools in the field of project evaluation
and risk management that are used to evaluate the possible risks and benefits connected with a
project. Every technique provides a different method for comprehending the variances and
uncertainties in project outcomes. A bank manager in the example used sensitivity analysis to
pinpoint project risks, particularly those pertaining to the project's estimated selling price. The
director of the company recommended a change to scenario analysis, nevertheless. The shift
from sensitivity analysis to scenario analysis necessitates a careful consideration of the
applicability and efficacy of both techniques in assessing project risks.

Understanding Sensitivity Analysis

Sensitivity analysis is a technique used to predict a decision's result given a set of parameters.
Sensitivity analysis looks at how alternative values of an independent variable affect a specific
dependent variable based on a set of assumptions by changing one variable at a time while
keeping the rest same. This method helps determine which factors are most important in
determining whether a project succeeds or fails.

Key features of Sensitivity Analysis:

1. Focus on Variables: It assesses the impact of individual variables on the overall

result.
2. Simple and Direct: It is easy to comprehend and implement, making it a preferred
initial tool for assessing risk.
3. Univariate Approach: It evaluates the effect of one variable at a time, which can be
limiting if variables are interconnected.

Applications in Project Appraisal:

 Identifying Critical Variables: Assists in determining which variables (such as selling

price, material costs, etc.) are crucial to the profitability of the project.
 Risk Management: Enables managers to concentrate on controlling the most sensitive
variables.
 Decision Making: Facilitates decision-making by highlighting potential areas of risk.

However, there are limitations to sensitivity analysis. It operates under the assumption of ceteris
paribus, meaning that all other variables remain constant while one variable is changed. This
assumption is often unrealistic in complex projects where multiple variables interact
dynamically. Additionally, sensitivity analysis does not offer a complete view of the project's risk.
This is where scenario analysis comes into play.
Understanding Scenario Analysis

Scenario analysis involves analyzing potential future events by considering different possible
outcomes or scenarios. Unlike sensitivity analysis, which focuses on changing one variable at a
time, scenario analysis examines the combined impact of changing multiple variables on the
project.

Key Features of Scenario Analysis:

1. Holistic View: Takes into account the interplay between multiple variables, providing a
holistic understanding of potential outcomes.
2. Multiple Scenarios: Develops various scenarios (such as best case, worst case, and
most likely case) to assess the project under different conditions.
3. Stress Testing: Evaluates the project's resilience against extreme yet plausible
scenarios.

Applications in Project Appraisal:

 Risk Assessment: The examination of different combinations of variables helps to gain

a more nuanced understanding of risks and their impact on the project.
 Strategic Planning: By anticipating various possible futures, strategic planning is
facilitated.
 Investment Decision: Highlighting the potential range of outcomes and their likelihood
aids in making informed investment decisions.

Comparing Sensitivity and Scenario Analysis

Sensitivity Analysis:

 Simplicity It is simple to perform and comprehend.

 Focus: It isolates the impact of individual variables.
 Limitations: However, it does not consider the interaction between variables and may
oversimplify complex projects.

Scenario Analysis:

 Complexity: It is more intricate and time-consuming.

 Comprehensiveness: It considers multiple variables and their interactions.
 Realism: This approach provides a more realistic and comprehensive risk assessment.

The Director’s Suggestion: Scenario Analysis

The Director's recommendation to utilize scenario analysis instead of sensitivity analysis is well-
founded for several reasons:
 1. Comprehensive Risk Assessment: Scenario analysis enables a wider and more
thorough comprehension of risks by taking into account the combined impacts of
multiple variables. This is particularly crucial for intricate projects where variables are
interconnected.
2. Preparation For Uncertainty: By formulating different scenarios, the company can be
better prepared for various future circumstances. This aids in devising contingency plans
and strategic responses to potential unfavorable conditions.
3. Strategic Insight: Scenario analysis provides valuable strategic insights by highlighting
potential opportunities and threats under different scenarios. This can assist in long-term
planning and decision-making.
4. Stress Testing: It allows the company to subject the project to extreme yet plausible
scenarios, ensuring its ability to withstand adverse conditions and remain viable.
5. Better Decision Making: With a more comprehensive understanding of risks, the
company can make more knowledgeable and confident decisions regarding the project.

CONCLUSION:

In summary, sensitivity analysis and scenario analysis play crucial roles in project evaluation
and risk management, each with their own strengths and limitations. Sensitivity analysis, due to
its simplicity and focus on individual variables, is an excellent starting point for understanding
the factors that have the greatest impact on a project's outcome. However, it may be limited in
complex projects where multiple variables interact.

On the other hand, scenario analysis takes a more comprehensive and realistic approach by
considering the combined effects of multiple variables. This method allows for a thorough
assessment of risks, better preparation for uncertainties, and strategic insights, making it a more
robust tool for evaluating project risks.

The Director's recommendation to replace sensitivity analysis with scenario analysis was truly
apt and perceptive. By embracing scenario analysis, the company can acquire a more profound
comprehension of potential risks and opportunities, resulting in better-informed decision-making
and enhanced project outcomes. In the ever-changing and frequently unpredictable realm of
project management, such a comprehensive method for evaluating risks is absolutely essential.
Answer 2)

INTRODUCTION:

Nurta Pharmaceuticals is facing a bit of a dilemma. They're trying to figure out how to make the
most of their earnings to keep their shareholders happy. Right now, they're earning Rs. 20 per
share, and they're giving all of that money back to their shareholders. But here's the catch: the
shareholders want a 20% return on their investment, and the market price of the share is Rs.
100.

Now, Nurta Pharmaceuticals has three different business opportunities on the table. Each
opportunity has a different expected rate of return: 25%, 20%, and 15%. But here's the thing,
they can only choose one. And they plan to fund it by keeping some of their earnings instead of
giving it all away. They're thinking of reducing the dividend payout to 50%, which means the
dividend per share would go down from Rs. 20 to Rs. 10.

So, what's the plan? Well, in this analysis, we're going to calculate the growth rate (that's g = b *
ROE) and the new share price for each option. We'll assume a constant growth rate and then
dive into what each choice means for the company and its shareholders.

CONCEPTS AND CALCULATIONS:

Growth Rate (g = b * ROE)

The company's earnings and dividends growth rate depends on two factors: the retention ratio
(b) and the return on equity (ROE). The retention ratio represents the earnings kept within the
business, which can be calculated as follows:

b = 1 – Dividend Payout Ratio

In this case, the dividend payout ratio is decreasing from 100% to 50%. Thus,

b = 1 – 0.50 = 0.50

Next, we need to calculate the return on equity (ROE) for each project. ROE is essentially the
expected return on the retained earnings invested in new projects. Here are the ROE values for
each option:

1. Option 1: ROE = 25%

2. Option 2: ROE = 20%
3. Option 3: ROE = 15%

To find the growth rate (g) for each option, we can use the following formula:

g = b × ROE

Now let's calculate the growth rate for each option:

Option 1: New Product with 25% Return

g = 0.50 × 25% = 12.5%

Option 2: Expansion of Current Product with 20% Return

g = 0.50 × 20% = 10%

Option 3: New Product with 15% Return

g = 0.50 × 15% = 7.5%

New Share Price

Moving on to the calculation of the new share price, we'll use the Gordon Growth Model (also
known as the Dividend Discount Model). The model is defined as:

P0 = D1 / (r - g)

Here's what each variable represents:

- P0 is the current share price

- D1 is the dividend expected next year

- r is the required rate of return

- g is the growth rate

Given that the new dividend payout is Rs. 10 and it will grow at the respective growth rates
calculated above, we can determine the new share prices for each option.

Option 1: New Product with 25% Return

P0 = 10 × (1 + 0.125) / (0.20 - 0.125) = Rs. 150

Option 2: Expansion of Current Product with 20% Return

P0 = 10 × (1 + 0.10) / (0.20 - 0.10) = Rs. 110

Option 3: New Product with 15% Return

P0 = 10 × (1 + 0.075) / (0.20 - 0.075) = Rs. 86

By using these calculations, we can determine the new share prices for each option based on
the given growth rates and dividend payout information.

Analysis and Conclusion

Option 1: New Product with 25% Return

If Nurta Pharmaceuticals decides to invest in this new product that promises a hefty 25% return,
they can expect a growth rate of 12.5%. What's even more exciting is that the share price will
shoot up to Rs. 150, showing a massive increase in value for the shareholders. This option is all
about maximizing shareholder wealth and points towards a bright future for the company.

Option 2: Expansion of Current Product with 20% Return

Now, if the folks at Nurta Pharmaceuticals choose to expand their current product, which offers
a solid 20% return, they can expect a growth rate of 10%. The new share price would be Rs.
110, which is a decent bump from the current market price of Rs. 100. While this option does
add value, it's not as impactful as Option 1.

Option 3: New Product with 15% Return

Last but not least, we have the option of investing in a new product that offers a 15% return.
This would result in a growth rate of 7.5%. However, the new share price would drop to Rs. 86,
which is actually lower than the current market price. This option doesn't seem to do much in
terms of enhancing shareholder value and might not be the most favorable choice.

CONCLUSION:

When it comes to deciding which business opportunity to pursue, the main goal is to maximize
shareholder wealth. Based on the analysis, here's what we've found:

Option 1 is the most favorable choice. With a growth rate of 12.5%, it significantly increases the
share price to Rs. 150. This is the option that promises the highest returns and really boosts the
company's value.

Option 2 provides a moderate benefit. The growth rate is 10%, and the share price would go up
to Rs. 110. It's not as impressive as Option 1, but it still adds value to the company.

Option 3 is the least attractive option. It only offers a growth rate of 7.5%, and the share price
could potentially drop to Rs. 86. This option doesn't seem to do much to enhance shareholder
value.

So, after carefully considering all the factors, it seems like Nurta Pharmaceuticals should go with
Option 1. This option not only gives them the highest growth rate but also significantly increases
the market valuation of the company. It's a clear reflection of the potential for strong future
earnings and dividends.
Answer 3)

INTRODUCTION:

Yield to Maturity (YTM) is a super important concept in bond investing. It basically tells us the
total return we can expect if we hold onto a bond until it matures. People often compare YTM to
the bond's coupon rate to figure out if it's a good investment. Understanding YTM helps
investors make informed decisions about bonds, assess the value of different bonds, and
manage interest rate risk.

CONCEPT of YTM:

YTM is basically the internal rate of return (IRR) on a bond. It takes into account all the future
coupon payments and the repayment of the bond's face value when it matures. We calculate it
by discounting those future cash flows back to the bond's current market price. It's expressed as
an annual percentage. The formula for calculating YTM is based on the present value of the
bond's cash flows, but it can be a bit tricky to solve since it involves finding the interest rate in
the present value equation.

Calculation of YTM for Shaurya Ltd Bonds

 Let's work through an example using Shaurya Ltd Bonds. Here are the details:
 Face value of the bond (F) = INR 100
 Coupon rate (C) = 5%
 Annual coupon payment (PMT) = 5% of 100 = INR 5
 Maturity period (N) = 4 years
 Current market price (P) = INR 96

We can approximate the YTM using the following iterative formula:

P = (C / (1+YTM)) + (C / (1+YTM)^2) + (C / (1+YTM)^3) + C + (F / (1+YTM)^N)

Given the complexity, financial calculators or software are usually used to solve this. But for a
rough estimate, we can use the following formula for bonds with annual coupons:

YTM ≈ (C + ((F - P) / N)) / ((F + P) / 2)

Let's plug in the values:

YTM ≈ (5 + ((100 - 96) / 4)) / ((100 + 96) / 2)

YTM ≈ 6.12%

This is just an approximation. For a more precise calculation, you'd need to use numerical
methods or a financial calculator.
CONCLUSION:

So, the YTM of Shaurya Ltd's bond, assuming the current market price is INR 96, is
approximately 6.12%. This tells us the annualized return considering all the future coupon
payments and the repayment of the face value at maturity. Investors can compare this yield with
other investment opportunities to figure out if the bond is a good bet.

Question 3b: Profit or Loss on Call Option

INTRODUCTION:

Options are financial contracts that give you the right, but not the obligation, to buy or sell an
asset at a specific price within a certain timeframe. Call options, in particular, allow you to buy
an asset and are commonly used for speculation or hedging. Understanding how the payoff
works in an option transaction is crucial for making informed trading decisions.

CONCEPT OF CALL OPTIONS:

A call option gives you the right to purchase the underlying asset, which in this case is shares of
Asus Ltd, at a strike price before the option expires. You have to pay a premium for this
privilege. Your profit or loss from the call option depends on the difference between the market
price of the asset at expiration and the strike price, adjusted for the premium you paid.

Calculation of Profit or Loss

Let's break it down using the following information:

 Number of shares in the option contract = 100

 Strike price (K) = INR 300
 Option cost (premium) = INR 2000
 Current market price at expiration (S) = INR 350

To calculate your profit or loss:

Step 1: Determine the intrinsic value of the option at expiration:

Intrinsic Value = (S - K)

Intrinsic Value = (350 - 300) = INR 50

Step 2: Calculate the total intrinsic value for the contract:

Total Intrinsic Value = Intrinsic Value per share × Number of shares

Total Intrinsic Value = 50 × 100 = INR 5000

Step 3: Subtract the cost of the option to determine your net profit or loss:
Net Profit/Loss = Total Intrinsic Value - Option Cost

Net Profit/Loss = 5000 - 2000 = INR 3000

CONCLUSION:

Assuming the market price at expiration is INR 350, Mohan's net profit from purchasing one call
option contract for Asus Ltd is INR 3000. This calculation shows how the value of the option
contract depends on the market price of the underlying asset being higher than the strike price
by an amount greater than the premium paid for the option. It highlights the potential for
significant returns in options trading with a relatively small investment in the option premium.
However, it's important to note that if the market price had been below the strike price, Mohan
would have incurred a loss limited to the premium paid, emphasizing the risk-reward dynamics of
options trading.