Beruflich Dokumente
Kultur Dokumente
Financial Analysis
Investment Decisions
Mona Iyer
CEPT University
Ahmedabad
Session Outline
• Investment Decisions
• Discounted Cash Flow Method
– NPV
– IRR
– PI
Investment Decisions
When do u need to take investment
decisions?
– Starting a new project
– Expanding the existing project
– Replacement and modernization
Investment Decisions
What are the features of Investment
Decisions?
– Current funds are allocated for future benefits
– Funds invested in long term assets
– Future benefits will occur over a long period
Why Important to take appropriate
investment decision?
– Involve commitment of large amount of funds
– Almost Irreversible decisions
– Long term Implications
Investment Decisions
Steps Involved in Investment Evaluation
– Estimating Cash Flows
– Estimating required rate of return
– Application of Decision Rule for selecting most appropriate
investment
Investment Evaluation Criteria/ Capital Budgeting
Techniques/Investment decision Rules
• Discounted Cash Flow (DCF) Criteria
– Net Present Value
– Internal Rate of Return
– Profitability Index
• Non-Discounted Cash Flow Criteria
– Pay Back Period
– Accounting Rate of Return
Time Value of Money
Suppose you have Rs. 100 today and you invest in some scheme with rate of return
10% per annum. Then to know cash in hand after One year your have to
compound it by compounding factor….
(C1)= 100* (1+0.1)=110
Now, assume a reverse scenario…that u know that u will have Rs. 110 cash after one
year and you want to know the present value of the same, then u will have to
discount it by discount factor (inverse of compounding factor)
Present value= 110* 1/(1+0.1)= 100
Important terms
Rate of Return/ Discount Rate /Opportunity cost of capital
Discount Factor
Present Value (Time Value of Money)
Net Present Value (NPV)
Suppose you have to make an investment of Rs. 100 today in a project…it will give you a
cash flow if Rs. 150 after 1 year.
What is the present value of your cash flow if discount rate is 10%
Thus your investment is worth more than it costs i.e it makes net contribution to value
NPV formula :
i.e. PV= C0
i.e. C0=C1/(1+r)
i.e. C1/(1+r)-C0=0
i.e. NPV = 0
Features of IRR
1. Value additivity principle does not apply
i.E For Project A and Project B
IRR (A+B) ≠ IRR A + IRR B
2. Depends on duration of project and sequence of cash
flow
3. While comparing two investments, Higher IRR does not
indicate necessarily better investment
Profitability Index
Ratio of Benefits to Costs
i.e. BC=PI=PV of cash flows/Initial Investment
• The payback rule ignores all the cash flows after cutoff
period regardless of the size of cash flow in the subsequent
year/s
– The cutoff should be fixed keeping in mind life of alternative
projects so that it does not end up accepting many poor short lived
projects and reject good long term projects.