Project Appraisal – Risk Analysis

Exercises

1. You are the financial manger of Bharat polymer products Ltd.(BPPL)

a highly profitable company. BPPL is planning an injection moulding plant at
Silvasa. Your project staff has developed the following cash flow for the
moulding plant project.
___________________________________________________________
Rs. in
million
Year 0 Years 1-10
Investment (250)
Sales 200
Variable costs( 60% of sales) 120
Fixed costs 20
Depreciation 25
Pre-Tax profit 35
Taxes 10
Profit after taxes 25
Cash flow from operations 50
Net cash flow 50

The range of values that the underlying variables can take is shown below:
Underlying Variable Pessimistic Expected Optimistic
Investment 300 250 200
(Rs. in million )
Sales (Rs. in million ) 150 200 275
Variable cost as percent 65 60 56
of sales
Fixed costs 30 20 15
Cost of capital (%) 14 13 12

1) What is the NPV of the project? Assume that the cost of capital is 13%
2) Calculate the accounting and the financial break-even point. Assume
(i) useful life = 10 years (ii) salvage value = 0 (iii) depreciation rate 10%
(SLM)
3) Calculate the effect of variations in the values of the underlying variables on
NPV

2. The following data relates to the probability distribution of the cash flows
for the first year of a project being floated by Fine Chemicals Ltd.
Cash flow Probability
1350 0.13
2500 0.25
4000 0.35
4500 0.27
Calculate a. Range
b. Mean Absolute Deviation (MAD)
c. Standard Deviation
 d. Coefficient of variation
e. Semi-variance
3. An investment project involves a current outlay of Rs. 1,00,000. The life of the
project is four years. The mean and standard deviation of the cash flows are as
given below:
Year Mean cash flow Standard deviation
(Rs.) (Rs.)
1 50,000 15,000
2 30,000 10,000
3 40,000 20,000
4 30,000 12,000
Required:
Calculate the expected Net Present Value and the standard deviation of
the Net Present Value.

4. Magna Oil is wondering whether to drill for oil in a certain basin

The prospects are as under:
Depth of Well Total Cost Cumulative Present Value of Oil
(in meters) (Rs. in crore) Probability of (Rs. in crore)
Finding Oil
500 4 0.5 10
750 5 0.6 9
1000 6 0.7 8
Required:
Draw a decision tree depicting this decision situation. Recommend a
strategy to be followed by Magna Oil.