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Q.3 If there is an initial investment of rupees 2000 and 3 years of positive cash flow of rupees 700
each. The discount rate is 10%. What is the present value of each cash flow?
Ans:
NPV = Present value of net cash flows
Where:
Ct = the net cash receipt at the end of year‘t‘
Io = the initial investment outlay
r = the discount rate/the required minimum rate of return on investment
n = the project/investment's duration in years
Year Cash Flow
Y1 2000
Y2 700
Y3 700
Y4 700
NPV = (0 + 578.51 + 525.92 + 478.11) – 2000
= -417.46
Q.4 What is credit risk appraisal? Explain the 5C’s of credit analysis
Ans: Credit appraisal involves analysis of liquidity position/ financial soundness of the company.
Although, the analysis also covers understanding growth trends in revenues and earnings, and profit
margins, more emphasis is required to be placed on liquidity-both long term and short term. Credit
analysis or credit appraisal typically involves micro-analysis of the key financial statements i.e.
Income Statement, Balance Sheet and Cash flow Statement. The important parameters that are to
be looked while analyzing liquidity are:
a) Debt Equity Ratio
b) Total Debt to Total Assets
c) Current Ratio and Quick Ratio
d) Sales to Working capital Ratio
e) Inventory Turnover Ratio
Along with the above mentioned ratios, one needs to look at aspects like aging schedule of
debtors, quality of inventory (fast-moving, slow-moving and obsolete). Credit risk analysis or credit
appraisal basically revolves around the premise of ability of borrower to service its debt through cash
flows. Primary cash flows are those that are generated through operations while secondary
cashflows are cash & cash equivalents plus marketable securities.
While analyzing credit risk of the borrower, the bank/ credit rating agency needs to consider even
the future growth potential of the business and incorporate in its judgment, those issues that can
possibly put business at risk. For this one needs to understand the future growth strategy & business
outlook and how the company wants to move ahead with its plans. The potential impact of any
future growth initiatives can be critical today as it may put additional stress on current profitability
and liquidity of the business.
Q.5 Classify projects based on the ways they influence investment decision process.
Ans: Classification of Investment Projects: Investment projects are classified into three categories on
the basis, of the way they influence the investment decision process: independent projects, mutually
exclusive projects and contingent projects.
Independent projects
An independent project is one, where the acceptance or rejection does not directly eliminate other
projects from consideration or affect the likelihood of their selection. For example, if management
plans to introduce a new product line, as well as, replace a machine which is currently producing a
different product. These two projects can be considered independent of each other, if there are
sufficient resources to adopt both, provided, they meet the firm’s investment criteria.
Mutually exclusive projects
The mutually exclusive projects are projects that cannot be followed at the same time. The
acceptance of one prevents the substitute proposal from accepting. Most of them have ‘either or’
decisions. You will not be able to follow more than one project at the same time. The evaluation is
done on a separate basis so that one that brings the highest value to the company is chosen.
Contingent projects
b. Discounted Cash Flow (DCF) is a method to estimate the project, company or assets investment
opportunity by means of the conception of time value for money. In DFC method, the project‘s
value is the future estimated cash flows discounted at a rate that reflect the risk of the projected
cash flow. A common practice is to use the DCF method to value companies or projects. There
are three major discounted cash flow analyses for project evaluation and selection. They are:
Internal Rate of Return (IRR)
Net Present Value (NPV)
Profitability Index (PI)
DFC is based on free cash flow which is a reliable method to cut through the unpredictability
and guesstimates involved in reported earnings. The free cash flow models examine the money
left for investors regardless of the cash outlay whether counted as an expense or turned into an
asset on the balance sheet. The DFC model applies as a sanity check.
Q.3 List the various criterions to be considered before identifying a project for investment.
Ans: Criteria for Selecting a Project
The task of identifying suitable projects for an investment involves in-depth study and appraisal. The
following are the criteria’s that one needs to look into before identifying a project:
Q.4. A firm’s market value of liability is 400 Rs. And the market value of equity is 600Rs. Cost of liability
is 7% and corporate tax 30% & cost of equity is 15%. What will be the weighted average cost of
capital?
Ans: Weighted Average Cost of Capital (WACC)
Where,
Re = Cost of equity = 15%
Rd = Cost of debt = 7%
E = Market value of the firm's equity = 600 Rs
D = Market value of the firm's debt = 400 Rs
V=E+D = 600 + 400 = 1000 Rs
E/V = Percentage of financing that is equity = 600/1000 = 0.6
D/V = Percentage of financing that is debt = 400/1000 = 0.4
Tc = Corporate tax rate = 30%
Q.6 Total cost of project is 250,000Cr. Expected return of project amount is 42,000 Cr. What is the
shortest payback period?
Ans: Payback Period PP = The Cost of Cash Inflows / Annual Cash Inflows
Here, Cost of Cash Inflows = 250,000 Cr., Annual Cash Inflows = 42,000 Cr.
So, PP = 250,000/42,000 = 5.95 Years