ANALYSIS

Calculation of total sales of the project

Years Capacity Production (in units) Local Sales Selling Price Total Sales
1 80% 2570 1850 4132 7644200
2 90% 2892 2085 4649 9692123
3 90% 2892 2085 4649 9692123
4 90% 2892 2085 4649 9692123
5 90% 2892 2085 4649 9692123
6 90% 2892 2085 4649 9692123
7 90% 2892 2085 4649 9692123
8 90% 2892 2085 4649 9692123
9 90% 2892 2085 4649 9692123
10 90% 2892 2085 4649 9692123

Calculation of variable Cost (in thousands, means 000)

Variable Cost Factors 1 2 3 4 5 6 7 8 9 10

in Years
Salaries & Wages 550 650 750 8000 8200 450 6200 8250 9775 1268
0 0 0 0 0
Electricity 128 145 156 2140 3250 159 3570 4150 4225 1478
4 6 0 0
Repairs & 500 564 528 598 574 563 521 591 540 578
Maintenance
Administration exp 350 320 280 300 380 210 158 176 170 220
Total 763 884 986 1103 1240 686 1044 1316 1471 1495
4 0 8 8 4 3 9 7 0 6
 Calculation of Net Profit of the Project (in thousands, means 000)

Total Sales Variable Cost Fixed Cost Gross Profit Tax @ 40% Net Profit
15000 7634 3500 3866 1546.4 2319.6
17000 8840 3500 4660 1864 2796
17300 9868 3500 3932 1572.8 2359.2
17500 11038 3500 2962 1184.8 1777.2
18000 12404 3500 2096 838.4 1257.6
18500 6863 3500 8137 3254.8 4882.2
18800 10449 3500 4851 1940.4 2910.6
19250 13167 3500 2583 1033.2 1549.8
22890 14710 3500 4680 1872 2808

Project Cost (in thousands, means 000)

  Phase-I Phase-II Total

Land 1495   1495
Civil Works 1621 538 2159
Buildings 1160 1788 2948
Contingency 140 116 256
Preliminary Expenses 341   341
Pre-operative Expenses 756   756
Margin money for Working capital 45   45
Total 5558 2442 8000

So, the total cost of project is of 80,00,000

Profitability Index or Benefit Cost

Present Value of Cash Inflows

PI =
Present Value of CashOutflows
Cash Flow

We are going to assume that the project we are considering has the following cash flow. Right now,
in year zero we will spend 8,000,000 rupees on the project. Then for 5 years we will get money back
as shown below.

Cash Flow (in thousands, means 000)

Year Cash flow

0 -8000
1 3733
2 3200
3 1600
4 1066
5 533

Payback

When exactly do we get our money back, when does our project break even? Figuring this is easy.
Take your calculator.

Running Total in Cash Flow (in thousands, means 000)

Yea Cash Running  

r flow Total
0 -8000 -8000  
1 3733 -4267 after the 1st year, the project has not yet broken even
2 3200 -1067 after the 2nd year, the project has not yet broken even
3 1600 533 the project breaks even sometime in the 3rd year
But when, exactly?

Negative Balance / Cash flow from the Break-Even When in the final year we break
Year even
1607 / 1600 0.666
So, we broke even 2/3 of the way through the 3rd year. So, the total time required to pay back the
money we borrowed was 2.66 years.
Discounted Payback

Is almost the same as payback, but before you figure it, you first discount your cash flows. You
reduce the future payments by your cost of capital. Why? Because it is money you will get in the
future, and will be less valuable than money today. (See Time Value of Money if you don't
understand). For this project, the cost of capital is 10%.

Running Total in Discounted Cash Flow (in thousands, means 000)

Year Cash flow Discounted Running Total

Cash flow
0 -8000 -8000 -8000
1 3733 3397 -4607
2 3200 2645 -1962
3 1600 1202 -760
4 1066 728 -32
5 533 331 299
So, we break even sometime in the 5th year. When?

Negative Balance / Cash flow from the Break-Even When in the final year we break
Year even
-0.096676737 0.096
So, using the Discounted Payback Method we break even after 4.096 years.

Net Present Value (NPV)

Once you understand discounted payback, NPV is so easy! NPV is the final running total number.
That's it. In the example above the NPV is 299. That's all. You're done, baby. Basically, NPV and
Discounted Payback are the same idea, with slightly different answers. Discounted Payback is a
period of time, and NPV is the final rupees amount you get by adding all the discounted cash flows
together. If the NPV is positive, then approve the project. It shows that you are making more money
on the investment than you are spending on your cost of capital. If NPV is negative, then do not
approve the project because you are paying more in interest on the borrowed money than you are
making from the project.

Projected Cost 8000000

Salvage Value 5500000
Cost of Capital 10%
Tax Rate 50%

CFBT Debt CBT Tax @ EAT CFAT 10%cap CP

 50%
6966 500 6466 3233 3233 3733 0.909 3393
5900 500 5400 2700 2700 3200 0.826 2643
2700 500 2200 1100 1100 1600 0.751 1202
1632 500 1132 566 566 1066 0.683 728
566 500 66 33 33 533 0.62 331
8297

Projected Cost −SalvageValue

Depreciation=
Number of Years
8000−5500
Depreciation=
5
Depreciation=500

Net Present Value=S umof Profit Volume−Initial Investment

Net Present Value=8297−8000
Net Present Value=+297

Profitability Index

NPV
Profitability Index= +1
Total Investment
297
Profitability Index= +1
8000
Profitability Index=1.0375
So, in our project, the PI = 1.0375. For every borrowed and invested we get back 1.0375, or one
rupee and 3 and one-third paise. This profit is above and beyond our cost of capital.

Internal Rate of Return

IRR is the amount of profit you get by investing in a certain project. It is a percentage. An IRR of 10%
means you make 10% profits per year on the money invested in the project. To determine the IRR,
you need your good buddy, the financial calculator.
 Year Cash flow 10%C PV 5%CAP PV
AP
0 -8000 1 -8000 1 -8000
1 3733 0.909 3393 0.95 3546
2 3200 0.826 2643 0.9 2880
3 1600 0.751 1202 0.86 1376
4 1066 0.683 728 0.81 863
5 533 0.62 331 0.77 410
297 1075

IRR=LR+ ( NPVPV@ LR ) R
297
IRR=10+(
1372 )
5

IRR=11.08

Modified Internal Rate of Return (MIRR)

It is basically the same as the IRR, except it assumes that the revenue (cash flows) from the project is
reinvested back into the company, and are compounded by the company's cost of capital, but are
not directly invested back into the project from which they came.

OK, MIRR assumes that the revenue is not invested back into the same project, but is put back into
the general "money fund" for the company, where it earns interest. We don't know exactly how
much interest it will earn, so we use the company's cost of capital as a good guess.

Why use the Cost of Capital?

Because we know the company wouldn't do a project, which earned profits below the cost of
capital. That would be stupid. The company would lose money. Hopefully the company would do
projects, which earn much more than the cost of capital, but to play it safe, we just use the cost of
capital instead. (We also use this number because sometimes the cash flows in some years might be
negative, and we would need to 'borrow'. That would be done at our cost of capital.)
How to get MIRR – OK?

We've got these cash flows coming in, right? The money is going to be invested back into the
company, and we assume it will then get at least the company's-cost-of-capital's interest on it. So,
we have to figure out the future value (not the present value) of the sum of all the cash flows. This,
by the way is called the Terminal Value. Assume, again, that the company's cost of capital is 10%.
Here goes.

Cash Flow Times   Future Value of that Note

year’s cash flow.
3733 X (1+. 1) ^ 5465 Compounded for 4
4 years
3200 X (1+. 1) ^ 4260 Compounded for 3
3 years
1600 X (1+. 1) ^ 1936 Compounded for 2
2 years
1066 X (1+. 1) ^ 1173 Compounded for 1
1 years
533 X (1+. 1) ^ 533 Not compounded at
0 all because this is the
final cash flow
      13367 This is the Terminal
Value

Why all those zeros?

Because the calculator needs to know how many years go by. But you don't enter the money from
the sum of the cash flows until the end, until the last year. Is MIRR kind of weird? Yep. You have to
understand that the cash flows are received from the project, and then get used by the company,
and increase because the company makes profit on them, and then, in the end, all that money gets
'credited' back to the project. Anyhow, the final MIRR is 10.81%.