The presentation covers financial feasibility of projects, payback analysis, NPV analysis or discounted cash flow analysis, IRR analysis, Benefit to cost ratio analysis, B/C pitfalls, ROI
2. Tools for financial feasibility analysis
• Payback period analysis
At what point of time we are making more money than we are spending ?
• Benefit cost ratio analysis
For each rupee how much will be generated?
• Net Present value analysis
How much is future revenue (or expenditure) flow worth in today ?
• Internal rate of return (IRR) analysis
rate of return on our investment for a fixed period, during which time we
are spending money and making money
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3. Payback Analysis
• A viable project is one that is able to pay back the original investment as early as
possible.
• The payback period is achieved at that point in time when cumulative cash inflows
more than offset cumulative outflows,
or
When we are finally making more money in total than we have spent in total.
• Payback period indicates when, our investment is out of the woods.
• Projects with long payback are less attractive than those with short payback.
- they tie up capital longer, not enabling its use for other productive purposes.
- they are generally riskier than those with short payback periods
as over a long stretch of time, many things can go wrong.
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4. Payback Analysis
• As per payback period, project A is more attractive
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Project A
Year Outflows
Cumulative
out flows
Inflows
Cumulative
In flows
1 200 200 100 100
2 200 400 300 400
3 100 500 300 700
4 500 300 1000
5 500 300 1300
Total 500 1300
Project B
Year Outflows
Cumulative
out flows
Inflows
Cumulative
In flows
1 200 200 100 100
2 200 400 100 200
3 100 500 200 400
4 500 400 800
5 500 500 1300
Total 500 1300
5. Net Present Value (NPV) Analysis
or Discounted cash flows analysis
• the late 1970s, Americans experienced inflation rates in the 17% per annum range
• Inflation provides one example of what is called the time value of money i.e. A
rupee today has a different value than a rupee one year from now.
• There is more to time value of money than the force of inflation.
• Consider if no inflation, i.e a rupee today has the same purchasing power as a
rupee one year later.
If you have an opportunity to lend Rs 1,000/- to a business at a 10% interest yearly
then at year end you will receive a payment of Rs 1,100/- at the year end when the
loan is paid off.
Your initial investment of Rs 1,000/- has grown by 10% over time.
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6. Net Present Value (NPV) Analysis
or Discounted cash flows analysis
• FV =PV (1+r)n
where r is interest rate fraction and n is number of completed time slots
Inflation provides one example of what is called the time value of money i.e. A rupee
today has a different value than a rupee one year from now.
• There is more to time value of money than the force of inflation.
• Consider if no inflation, i.e a rupee today has the same purchasing power as a
rupee one year later.
If you have an opportunity to lend Rs 1,000/- to a business at a 10% interest yearly
then at year end you will receive a payment of Rs 1,100/- at the year end when the
loan is paid off.
Your initial investment of Rs 1,000/- has grown by 10% over time.
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7. Net Present Value (NPV) Analysis
• Project A is more attractive
than Project B, because its
true, discounted profit (Rs
533.18) is greater than the
discounted profit of Project B
(Rs 485.24).
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Project A
Year Outflows Inflows
Discounting
factor @ 10%
PV of
out flows
PV of
In flows
PV of
Net flows
1 200 100 0.9091 181.82 90.91 -90.91
2 200 300 0.8264 165.28 247.92 82.64
3 100 300 0.7513 75.13 225.39 150.26
4 300 0.683 0 204.9 204.9
5 300 0.6209 0 186.27 186.27
Total 500 1300 422.23 955.39 533.16
Project B
Year OutflowsInflows
Discounting
factor @ 10%
PV of
out flows
PV of
In flows
PV of
Net flows
1 200 100 0.9091 181.82 90.91 -90.91
2 200 100 0.8264 165.28 82.64 -82.64
3 100 200 0.7513 75.13 150.26 75.13
4 400 0.683 0 273.2 273.2
5 500 0.6209 0 310.45 310.45
Total 500 1300 422.23 907.46 485.23
8. Net Present Value (NPV) Analysis
• Both projects have
same NPV
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Project A
Year Outflows Inflows
Discounting
factor @ 10%
PV of
out flows
PV of
In flows
PV of
Net flows
1 200 0.9091 181.82 0 -181.82
2 200 0.8264 165.28 0 -165.28
3 100 100 0.7513 75.13 75.13 0
4 200 0.683 0 136.6 136.6
5 500 0.6209 0 310.45 310.45
Total 500 800 422.23 522.18 99.95
Project B
Year OutflowsInflows
Discounting
factor @ 10%
PV of
out flows
PV of
In flows
PV of
Net flows
1 50 0.9091 45.455 0 -45.46
2 200 0.8264 165.28 0 -165.28
3 200 100 0.7513 150.26 75.13 -75.13
4 89.65 200 0.683 61.23095 136.6 75.37
5 500 0.6209 0 310.45 310.45
Total 539.65 800 422.226 522.18 99.95
9. Internal rate of return(IRR) Analysis
• Both projects have same NPV
• By Excel function IRR of project
A is 14 % and Project B is 12 %
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Project A
Year Outflows Inflows
Discounting
factor @ 10%
PV of
out flows
PV of
In flows
PV of
Net flows
1 -200 0.9091 181.82 0 -181.82
2 -200 0.8264 165.28 0 -165.28
3 -100 100 0.7513 75.13 75.13 0
4 200 0.683 0 136.6 136.6
5 500 0.6209 0 310.45 310.45
Total -500 800 422.23 522.18 99.95
Project B
Year Outflows Inflows
Discounting
factor @ 10%
PV of
out flows
PV of
In flows
PV of
Net flows
1 -50 0.9091 45.455 0 -45.46
2 -200 0.8264 165.28 0 -165.28
3 -200 100 0.7513 150.26 75.13 -75.13
4 -89.65 200 0.683 61.23095 136.6 75.37
5 500 0.6209 0 310.45 310.45
Total -539.65 800 422.226 522.18 99.95
10. Internal rate of return(IRR) Analysis
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Project A discounting @ 15 %
Year Outflows Inflows
Discounting
factor @ 15%
PV of
out flows
PV of
In flows
PV of
Net flows
1 200 0.8696 -173.92 0 -173.92
2 200 0.7561 -151.22 0 -151.22
3 100 100 0.6575 -65.75 65.75 0
4 200 0.5718 0 114.36 114.36
5 500 0.4972 0 248.6 248.6
Total 500 800 -390.89 428.71 37.82
Project B discounting @ 15 %
Year Outflows Inflows
Discounting
factor @ 15%
PV of
out flows
PV of
In flows
PV of
Net flows
1 50 0.8696 -43.48 0 -43.48
2 200 0.7561 -151.22 0 -151.22
3 200 100 0.6575 -131.5 65.75 -65.75
4 89.65 200 0.5718 -51.2619 114.36 63.1
5 500 0.4972 0 248.6 248.6
Total 539.65 800 -377.462 428.71 51.25
Project A discounting @ 20 %
Year Outflows Inflows
Discounting
factor @ 20%
PV of
out flows
PV of
In flows
PV of
Net flows
1 200 0.8333 -166.66 0 -166.66
2 200 0.6944 -138.88 0 -138.88
3 100 100 0.5787 -57.87 57.87 0
4 200 0.4823 0 96.46 96.46
5 500 0.4019 0 200.95 200.95
Total 500 800 -363.41 355.28 -8.13
Project B discounting @ 20 %
Year Outflows Inflows
Discounting
factor @ 20%
PV of
out flows
PV of
In flows
PV of
Net flows
1 50 0.8333 -41.665 0 -41.67
2 200 0.6944 -138.88 0 -138.88
3 200 100 0.5787 -115.74 57.87 -57.87
4 89.65 200 0.4823 -43.2382 96.46 53.22
5 500 0.4019 0 200.95 200.95
Total 539.65 800 -339.523 355.28 15.76
11. Internal rate of return(IRR) Analysis
• IRR of Project A is 19% and of
Project B is 23 %
• a project's IRR is higher than the
prevailing interest rate, then it
may be smart to invest in it.
• IRR model assumes that money
employed is utilized all the time
and is not remain unutilized at all.
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Project A
Year Outflows Inflows
Discounting
factor @ 19%
PV of
out flows
PV of
In flows
PV of
Net flows
1 -200 0.8403 -168.06 0 -168.06
2 -200 0.7062 -141.24 0 -141.24
3 -100 100 0.5934 -59.34 59.34 0
4 200 0.4987 0 99.74 99.74
5 500 0.419 0 209.5 209.5
Total -500 800 -368.64 368.58 -0.06
Project B
Year Outflows Inflows
Discounting
factor @ 10%
PV of
out flows
PV of
In flows
PV of
Net flows
1 -50 0.813 -40.65 0 -40.65
2 -200 0.661 -132.2 0 -132.2
3 -200 100 0.5374 -107.48 53.74 -53.74
4 -89.65 200 0.4369 -39.1681 87.38 48.21
5 500 0.3552 0 177.6 177.6
Total -539.65 800 -319.498 318.72 -0.78
12. Benefit to Cost ratio
The benefit-cost ratio is nothing more than a measure of benefit divided by a measure of cost.
Measure of benefit can be anything: financial profit/ cost savings, happiness, error reduction,
throughput time, and so on.
Practically, the measure of benefit is revenue - or in non- revenue generating situations, cost
savings.
Benefit-cost ratio (B/C) > 1.0 Revenue is greater than expenditures. i.e. investment is
profitable.
Benefit-cost ratio (B/C) = 1.0. Revenue and expenditures offset each other.
Consequently, you are facing a breakeven situation.
Benefit-cost ratio (BE) < 1.0. In this case, expenditures outstrip revenue. You are losing money.
Example: BIC = Rs 40,000/Rs 50,000 = 0.8 Interpretation: For each dollar you are spending on
this project, you are only gaining 80 cents of revenue. Thus you are losing money.
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13. Benefit to Cost ratio
Discounted B/C for project A
= 428.71/390.89 =1.09
Discounted B/C for project B
= 428.71/377.46 =1.14
B/C for project A = 800/500 =1.6
B/C for project B = 800/539.65 =1.48
Benefit-cost ratio analysis using discounted
cash flow data, the computing what in
finance is called the profitability index.
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Project A
Year Outflows Inflows
Discounting
factor @ 15%
PV of
out flows
PV of
In flows
PV of
Net flows
1 200 0.8696 173.92 0 -173.92
2 200 0.7561 151.22 0 -151.22
3 100 100 0.6575 65.75 65.75 0
4 200 0.5718 0 114.36 114.36
5 500 0.4972 0 248.6 248.6
Total 500 800 390.89 428.71 37.82
Project B
Year Outflows Inflows
Discounting
factor @ 15%
PV of
out flows
PV of
In flows
PV of
Net flows
1 50 0.8696 43.48 0 -43.48
2 200 0.7561 151.22 0 -151.22
3 200 100 0.6575 131.5 65.75 -65.75
4 89.65 200 0.5718 51.26 114.36 63.1
5 500 0.4972 0 248.6 248.6
Total 539.65 800 377.46 428.71 51.25
14. Benefit to Cost ratio for non-revenue generating
project
Many projects that are carried out are not revenue generating
Ex. . a typical information technology (IT) project in an organization
This can improve revenue performance indirectly, as the organization reduces
operating costs. But it is not directly tied to generating revenue
Benefit-cost ratio analysis for this involves cost saving instead of revenue generation.
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15. B/C ratio : pitfalls
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There are a number of pitfalls associated with benefit-cost analyses that are
important to know.
B/C ratios do not provide information on the size of the numbers being reviewed.
EX: Project A BIC = 3.1 Project B BIC = 2.7 Project A's is
better
Project A BIC = 3100/1000 = 3.1 Project B BIC = 2,700,000/1,000,000 = 2.7
• Since B/C is a ratio, sense of the size of the numbers vanishes. For most
organizations, Project B is more attractive than A, as B has substantial revenue.
• For valid comparisons among the B/C ratios of different projects, One must know
the actual size of the numbers that are used to compute the ratios.
16. B/C ratio : pitfalls
1. B/C ratios do not provide information on when payback occurs. Consider the following
two ratios: Project A B/C = 3.1 Project B B/C = 2.7
Again, Project A appears to be more attractive than Project B.
If Project A realizes a B/C of 3.1 after five years, it is less attractive than Project B, if
B realizes its B/C ratio in two years.
2. The easiest quantitative data to acquire is basic business data derived from estimated
budgets and, possibly, on anticipated revenues. Hard-to-measure factors are often ignored
when computing the ratios. For example, the main benefit of a project may be what is
called a second-order benefit - e.g., this project, while not profitable in itself, will provide
the groundwork for major revenue streams generated on future projects.
Another benefit might be improved public perceptions of the company's activities.
None of these pitfalls is fatal. With B/C, analysts should be aware of their existence and
should strive to deal with them so that the analyses are valid.
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17. Return on Investment (ROI)
The ROI is nothing more than a measure of NPV expressed as percentage of present
value of cost.
ROI = (NPV/PV of cost)x 100= (discounted B/C -1)x 100
ROI> 0 Revenue is greater than expenditures. i.e. investment is profitable.
ROI= 0. Revenue and expenditures offset each other.
Consequently, you are facing a breakeven situation.
ROI< 0. In this case, expenditures outstrip revenue. You are losing money.
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18. Thank You
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Contact
Email: naimkidwai@gmail.com
https://nrkidwai.wordpress.com/