CAIIB ABFM Module B Mini Marathon 3

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1. ABC Ltd. is considering Its new project with the following details: (Rs
Crore)
Initial Capital Cost = 400; Annual Unit Sales = 5 Cr;
Selling Price Per Unit = Rs 100; Variable Cost Per Unit = Rs 50
Fixed Cost Per Year = Rs 50 Cr; Discount Rate = 6%; Tax = Nil
Compute the Net Cash Inflow for the year.
(a) 200 Cr
(b) 300 Cr
(c) 100 Cr
(d) 400 Cr
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2. Analyse how sensitive a project is to changes in initial project cost,
cash inflow, and cost of capital using the following information regarding
the project: Identify which of the three factors, the project is most
sensitive to, if the variable is adversely affected by 10%?
Initial Project Cost (Rs.) 1,20,000; Annual Cash Inflow (Rs.) 45,000
Project Life (Years) 4; Cost of Capital 10%;
Use annuity factors: 10% = 3.169 and 11% = 3.103 to compute NPV of
cash inflows. [factor Initial Cost of Capital]
(a) 22605
(b) 62405
(c) 10605
(d) 72605
Particulars NPV
A SP (I) NPV (I)
B VC (I) NPV (D)
C FC (I) NPV (D)
D Volume (I) NPV (I)
E Initial Investment (I) NPV (D)
F Life of Project (I) NPV (I)
G Cost of Capital (I) NPV (D)
3. Analyse how sensitive a project is to changes in initial project cost,
cash inflow, and cost of capital using the following information
regarding the project:
Initial Project Cost (Rs.) 1,20,000; Annual Cash Inflow (Rs.) 45,000
Project Life (Years) 4; Cost of Capital 10%;
Use annuity factors: 10% = 3.169 and 11% = 3.103 to compute the
NPV if, COC is varied adversely by 10%.
(a) 12605
(b) 19635
(c) 32605
(d) 10605

Year Rs
Initial Project Cost (120000)
Annual Cash Inflow 45000
PV @10% 3.169
PV of Cash inflows 142605
NPV 22605
Situation NPV Change in NPV
Base (Present) 22605 -
Initial Cost Project – adverse (I) 142605 – 132000 = 22605-10650/ 22605 =
1,20,000 * 1.1 = 1,32,000 10605 53.08%
Annual Cash Inflow (D) (40500 * 3.169) – 22605- 8345/ 22605 =
45,000 *.9 = 40500 120000 = 8345 63.08%
Cost of Capital (I) 10% * 10% = (45000 * 3.103) – 22605- 19635/ 22605
11% Telegram Channel - 120000 = 19635 = 13.14%
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4 Which of the following indicates business risk?
a. Financial leverage
b. Operating leverage
c. Combined leverage
d. Total Leverage

5. Decision Tree method, which a ______of possible outcomes(with their
associated probability), attached to each decision.
a. Tabular representation
b. Graphical representation
c. Either a or b
d. None of these

▪ This process of evaluation starts from the last branch of the tree till we
come to the starting point of the tree.
▪ For example, if the probability associated with NPV of Rs. 5 lakh is 40%
and that associated with NPV of Rs. 4 lakh is 60%,
▪ the estimated NPV is: (5 * 0.4) + (4 * 0. 6) = Rs. 4.4 lakh.
▪ We can continue to move backward in the decision tree, calculating the
estimated NPV at each node, selecting the decision of higher value and
discarding the other, till we come to the starting point
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▪ Compute the net present value for a project with a net initial investment
of Rs. 1,00,000. The net cash flow for year one is Rs. 55,000; for year
two is Rs. 80,000 and for year three is Rs. 15,000. Further, the
company’s cost of capital is 10%. [PVIF @ 10% for three years are
0.909, 0.826 and 0.751]
Year Cash Flow PVIF @10% Discounted Cash Flow
0 (100000) 1 (100000)
1 55000 0.909 49995
2 80000 0.826 66080
3 15000 0.751 11265
NPV 27340
▪ Recommendation: Since the net present value of the project is positive,

the company should accept the project
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❑ The following example will illustrate the calculations involved in arriving
at the IRR. Following are the cash flows of the project of XYZ Ltd.
Year 0 1 2 3 4
Cash Flow (200000) 60000 60000 80000 90000
❑ The IRR is the value of r which satisfies the following equation:
2,00,000 = 60,000 /(1 + r)1 + 60,000 / (1 + r)2 + 80,000/ (1 + r)3 +
90,000 /(1 + r)4
❑ try r = 14%
60,000/ (1.14)1 + 60,000 /(1.14)2 + 80,000/ (1.14)3 + 90,000/
(1.14)4 = 2,06,085
❑ R= 15%
60,000/ (1.15)1 + 60,000/(1.15)2 +80,000 /(1.15)3 + 90,000 (1.15)4
= 2,01,601
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❑ R= 16%
60,000/(1.16)1 + 60,000 /(1.16)2 + 80,000 /(1.16)3 + 90,000/
(1.16)4 = 1,97,272
1. Determine the net present value of the two closest rates of return.
(NPV/ 15 percent) = 1,601
(NPV/ 16 percent) = (2,728)
2. Find the sum of the absolute values of the net present values
1,601 + 2,728 = 4,329
3. Calculate the ratio of the net present value at the smaller discount
rate = 1,601/ 4,329 = 0.37
4. Add the number obtained to the smaller discount rate:
= 15 + 0.37 = 15.37%
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IRR: Accept: If the IRR is greater than the cost of capital
Reject: If the IRR is less than the cost of capital
➢ The calculation of MIRR can be illustrated through the following

example. Square Limited is evaluating a project which has the following
initial investment and cash inflows:
Year 0 1 2 3 4 5 6
Cash -240 -160 40 120 160 200 240
Flow
The cost of capital for Square Ltd is 15 %

❑ Present value of cost = 240 + 160/(1.15) = 379.13
❑ Terminal value of cash inflows = 40(1.15)4 + 120(1.15)3 + 160(1.15)2 +
200(1.15) + 240 = 69.96 + 182.51 + 211.60 +230 + 240 = 934.07
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▪ MIRR is computed as follows:
▪ PVC = Terminated Value / (1+MIRR)n
▪ 379.13 = 934.07 /(1 + MIRR)6
▪ (1 + MIRR)6 = 934.07/379.13 = 2.463
▪ 1 + MIRR = 2.4631/6 = 1.162
▪ MIRR = 1.162 – 1 = 0.162 = 16.2%
▪ Conclusion: As the MIRR is higher than the cost of capital, the project is
acceptable.
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➢ Profitability Index
▪ This is an index that either explains or represents the relationship
between the cost and the benefit of a project proposal.
▪ It is also called value investment ratio or profit investment ratio.
▪ PI is calculated by dividing the present value of future expected cash
flows by the initial investment amount in the project.
▪ Higher the Index better is profitability of the project. Anything below 1

indicates that the project is unprofitable.
▪ Mathematically: The Profitability Index (PI) is calculated as below:)
Profitability Index (PI) = Sum of discounted cash inflows/
Initial cash outlay or Total discounted cash outflow (as the
case may be
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▪ Recommendation: Since the net present value of the project is positive,

➢ The calculation of MIRR can be illustrated through the following

The cost of capital for Square Ltd is 15 %

▪ Higher the Index better is profitability of the project. Anything below 1

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