Lecture 09

TVM techniques to evaluate projects

COURSE OUTLINE

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Week 01 Introduction to Financial Management

Week 02 Accounting principles and financial statements
Week 03 Ratio & Cost Benefit Analysis
Week 04 Sources of finance for projects
Week 05 Time Value for Money concept
Week 06 Quiz, Problems & Revision
Week 07 Project Presentation
Week 08 - Mid-term Examination
Week 09 - TVM techniques to evaluate projects
Week 10 - Role of taxation & interest in Project Management
Week 11 - Effects of Inflation & depreciation on projects
Week 12 - Comparing mutually exclusive projects
Week 13 - Making a business case for the project
Week 14 Quiz, Problems & Revision
Week 15 Project Presentation
Week 16 - Final Examination

LECTURE OUTLINE
Net Present Value (NPV)
Internal Rate of Return (IRR)

Discounted Pay Back period (DPB)

Net Present Value (NPV)

NPV is used in capital
budgeting to analyze the
profitability of an
investment or project
over time
It is the difference
between present value of
cash inflows and the
present value of cash
outflows

NPV result, significance & consequent action

o Benefit : NPV converts a projects future cash flows into todays

dollars, which helps you in making a reasonably realistic estimate
o Limitation : NPV is based on future cash flows and the discount
rate, both of which are hard to estimate with 100% accuracy

Net Present Value (NPV) Formulas

o When net cash flows are even
C x 1 (1 + i) -n Initial investment
i

o When net cash flows are not even

C1
+
(1+i) 1

C2 +
(1+i) 2

Cn
. - Initial investment
(1+i) n

C = net cash inflow, i = required rate of return, n = number of periods

Net Present Value (NPV) Table

Net Present Value (NPV) Example

Q. Calculate the net present value of a project which requires an
initial investment of Rs. 243,000 and it is expected to generate a cash
inflow of Rs. 50,000 each month for 12 months. The target rate of
return is 12% per annum.
Answer : Rs. 319,754
Q. An initial investment on plant and machinery of Rs. 8,320
thousand is expected to generate cash inflows of Rs. 3,411 thousand,
Rs. 4,070 thousand, Rs. 5,824 thousand and Rs. 2,065 thousand at
the end of first, second, third and fourth year respectively. At the end
of the fourth year, the machinery will be sold for Rs. 900 thousand.
Calculate the present value of the investment if the discount rate is
18%.
Answer : Rs. 2,568

Internal Rate of Return (IRR)

IRR of an investment is the discount
rate at which the NPV of costs
(negative cash flows) of the
investment equals the NPV of the
benefits (positive cash flows) of the
investment hence where NPV = 0
An investment is considered
acceptable if its internal rate of
return is greater than an
established minimum acceptable
rate of return. The project with the
highest IRR would be considered
the best and undertaken first

Internal Rate of Return (IRR) Formula

IRR = Li +

Linpv
x (Hi-Li)
Linpv - Hinpv

Li = Lower discount rate, Hi = Higher discount rate

Linpv = NPV at lower discount rate, Hinpv= NPV at higher discount rate

o If the IRR is greater than the required return, accept the project
o If the IRR is less than the required return, reject the project

Internal Rate of Return (IRR) Example

Q. Assume Najeeb enterprises must decide whether to
purchase a piece of factory equipment for Rs. 300,000. The
equipment would only last three years, but it is expected to
generate Rs. 150,000 of additional annual profit during
those years. The enterprise also thinks it can sell the
equipment for scrap afterward for about Rs. 10,000. Using
IRR, the enterprise can determine whether the equipment
purchase is a better use of its cash than its other
investment options, which should return about 10%
Answer : 24.31%

Discounted Payback Period (DPB)

Discounted payback period is a
variation of payback period
which accounts for time value
of money by discounting the
net cash flows from a project
Discounted payback period is
more reliable than simple
payback period since it
accounts for time value of
money

Discounted Payback Period example

Q. An initial investment of $2,324,000 is expected to generate $600,000 per
year for 6 years. Calculate the discounted payback period of the investment
if the discount rate is 11%
Yr

NCF

0
1
2
3
4
5
6

2,324,000
600,000
600,000
600,000
600,000
600,000
600,000

PV Factor
(1/(1+i)n)
1.0000
0.9009
0.8116
0.7312
0.6587
0.5935
0.5346

DCF
(CFPV)
2,324,000
540,541
486,973
438,715
395,239
356,071
320,785

A - (B/C)
6 - (214,323/320,785) = 5.33 years

CDCF

2,324,000
1,783,459
1,296,486
857,771
462,533
106,462
214,323

Learning outcomes
What is NPV, IRR and DPB
Calculations and implicatons invovled
How to interpret and analyze values