LEADSTAR COLLEGE OF MANAGEMENT AND LEADERSHIP

FACULTY OF BUSINESS AND LEADERSHIP

GRADUATE DEPARTMENT OF BUSINESS ADMINISTRATION

TERM PAPER FOR THE COURSE:FINANCIAL MANANGEMENT

CASE STUDY ON CAPITAL BUDGETING DECISION OF

DASHEN BANK SHARE COMPANY (DBSC)

SUBMITTED TO: Teshale G. (Asst. Prof)

PREPARED BY: AMENTI ERENA

ID No. LMBA /1873/15

MARCH 20, 2016

ADDIS ABABA

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Case Description

This case is adapted from a similar case study developed by Meric, Dunne, Li and Meric (2010).
Interested students can workout the entire case reference below:
Meric, I., Dunne, Li, S, F., & Meric, G. (2010). Variety Enterprise Corporation: Capital Budgeting
Decision. Review of Business & Finance Case Studies, 1(1), 15-25.

The capital budgeting decision is one of the most important financial decisions in business firms. In
this case, Dashen Bank Share Company (DBSC) is considering whether to invest in a system to
modernize its local money transfer services. To determine if the project is profitable, DBSC must first
determine the weighted average cost of capital to finance the project. The simple payback period,
discounted payback period, net present value (NPV), internal rate of return (IRR), and modified
internal rate of return (MIRR) techniques are used to study the profitability of the project. MIRR is a
relatively new capital budgeting technique, which assumes that the reinvestment rate of the project’s
intermediary cash flows is the firm’s cost of capital. The stand-alone risk of the project is evaluated
with the sensitivity analysis and scenario analysis techniques assuming that manufacturing the new
product would not affect the current market risk of the company. The case gives students an
opportunity to use the theoretical profitability and risk analysis techniques explained in standard
finance textbooks in a real-world setting. The case is best suited for MBA and Master of accounting
students and is expected to take approximately three to four hours to complete. The case may also be
appropriate for undergraduate senior finance majors.

KEYWORDS: Capital budgeting, weighted average cost of capital, cash flow, payback period, net
present value, internal rate of return, modified internal rate of return, sensitivity analysis, scenario
analysis.
Case Information
DBSC is planning to invest in a special system to deliver local money transfer services to its
customers. The invoice price of the system is $280,000 in subject to 15% non refundable VAT. It
would require Birr 18,000.00 in shipping expense and installation costs. The system will be
depreciated using straight line method with 25%annual rate on original cost of the system. DBSC
plans to use the system for four years and it is expected to have a salvage value of $ 80,000 after four
years of use.
The Bank expects the system will increase the number of local money transfer customers by 100,000.
The company estimates that it will charge on the average Br.5 fee per customer for the transfer service
in the first year with a cost of Br.3 per customer, excluding depreciation. Management forecasts that
both the service fee and cost per customer will increase by 10% per year due to inflation excluding
depreciation. DBSC’s net operating working capital would have to increase by 18% of sales revenues
to produce the new product. The Bank is subject to 30% income tax.

DBSC’s WACC

Guta, a recent MBA graduate of Addis Ababa University, is conducting the capital budgeting analysis
for the project. The company hired her only a few weeks ago as the head of the newly formed Capital
Budgeting Analysis Department. In order to evaluate the feasibility of the investment in the new
system, Guta’s first task is to estimate DBSC’s WACC. He plans to use the financial data in Exhibit 1
to estimate the WACC. When DBSC started evaluating the project, the following conversation took

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place between Guta & Ato Ali. Ato Ali, the CEO of the Bank, is a London School of Business
graduate with a major in financial economics and long years of administrative experience.

Guta: It may be difficult to estimate the cost of borrowing in the current recessionary environment.
Ali: We can determine the yield to maturity (YTM) on our outstanding bonds by using their current
market prices. We can assume that we will be able to issue additional bonds with this YTM as the cost
of borrowing. We should be able to place the new bonds without any flotation costs. Therefore, we can
assume no flotation costs in our calculations. We can re-examine the feasibility of the project later
before raising funds by using sensitivity analysis to assess the impact of possible changes in interest
rates on the NPV of the project.
Guta: Do you think the company’s current market value capital structure is optimal? Can we use the
current percentages of the capital components as weights in the calculation of the company’s WACC?
Ali: Yes, I believe that the company’s current market value capital structure of 30% debt, 10%
preferred stock and 60% equity is optimal. We have about Br. 95,000 in retained earnings this year,
which is also available in cash. We should be able to use this year’s retained earnings to finance part
of the equity financing required for the project. However, we will have to issue some new common
shares for the remainder of the necessary equity financing. We can assume a flotation cost of about
10% for the new common shares.
Guta: There are three basic methods of calculating a firm’s cost of equity when retained earnings are
used as equity capital: 1) the capital asset pricing method (CAPM); 2) the discounted cash flow (DCF)
approach; and, 3) the bond-yield-plus-risk-premium method. Which of these methods should we use in
the calculation of our cost of retained earnings?
Ali: Although each of these methods has its merits, I believe that the most appropriate approach for
our company would be to find an average cost with the three methods. Besides, we can consider the
yield on the Ethiopian Government TB risk free return on investment in the computation of cost of
common equity.

Ato Ali gave only one week to Guta for his estimation of DBSC’s WACC. With the instructions he
received from Ato Ali and with the help of the financial data in Exhibit 1, Guta began the task of
estimating the Bank’s WACC immediately.

Ato Ali knew that estimating the bank’s cost of capital was the first critical step in the capital
budgeting process. Without this analysis, it would not be possible to determine if the new system
would be a profitable investment for DBSC. That is why he had asked Guta to estimate the bank’s
WACC as the first task. Ato Ali was very pleased when he received Guta’s calculation results and the
WACC estimate. He thought that he had made a good decision in hiring Guta as the head of the
company’s newly established Capital Budgeting Analysis Department.

Exhibit 1: Financial data Guta plans to use in estimating DBSC’s WACC

DBSC’s current market value optimal capital structure:

Amount Weight

Bonds $30,000,000 30%

Preferred Stock 10,000,000 10%
Common Equity 60,000,000 60%

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Data to be used in the calculation of the cost of borrowing with bonds:
Par value = Br 1,000, non-callable
Market value = Br 1,058.59
Coupon interest = 9% (semiannual payment)
Remaining maturity = 15 years
Flotation costs =0

Data to be used in the calculation of the cost of preferred stock:

Par value =Br100
Annual dividend = 9% of par
Market value = Br102
Flotation cos t = 7%

Data to be used in the calculation of the cost of common equity:

CAPM data: DBSC’s beta = 1.2
The yield on Ethiopian Gov’t T-bond =2%
Market risk premium = 6%
DCF data: Stock price = Br.19.08
Last year’s dividend (D0) = Br.1.00
Expected dividend growth rate = 5%
Bond-yield-plus-risk-premium: Risk premium = 3.5%
Amount of retained earnings available = Br.95,000.00
Amount of new common stock to be issued = (Br365,000) (0.6) - 95,000 = Br124,000
This exhibit shows the data needed to estimate the firm’s WACC. Specifically, it first presents VEC’s current market value optimal
capital structure used to determine the weights in the WACC calculation. It then provides the data required to calculate the cost of debt,
the cost of preferred stock and the cost of common stock. The figures are computed based on analysis of investment in the Ethiopian
banking industry. The amount of new common stock to be issued is provided at the end of the exhibit.

Analysis of the Profitability of the Project

Ato Ali and Guta had the following conversation regarding how they should evaluate the potential
profitability of the project.
Guta: With the sales and cost estimates I have obtained from the marketing and accounting
departments in Exhibit 2, we should be able to estimate the project’s cash flows for the four- year
horizon.
Ali: Excellent! How are we going to evaluate the project’s profitability to determine if it is feasible?
Guta: The Net Present Value (NPV) and Internal Rate of Return (IRR) methods are generally used in
the evaluation of projects. However, these two methods have different assumptions regarding the
reinvestment rate of the intermediary cash flows. The NPV method assumes that the intermediary cash
flows can be reinvested at the firm’s cost of capital. However, the IRR method assumes that the
reinvestment rate is the project’s IRR. Academicians argue that the reinvestment rate assumption of
the NPV method is more realistic. Therefore, they recommend the NPV method. The financial goal of
a firm is to maximize market value. The NPV of a project shows its contribution to the market value of
the firm.
Ali: Correct! However, the NPV is a dollar amount. It is difficult to explain the profitability of a
project as a dollar amount to the stockholders of the company. It is easier to compare the project’s IRR
with the firm’s WACC to convince the stockholders that we can earn a higher percentage return on the
investment than what it would cost to finance it. I have heard that there is a new improved capital
budgeting technique that measures the profitability of a project as a percentage similar to the IRR
method and it assumes that the project’s intermediary cash flows can be reinvested at the firm’s cost of
capital as in the NPV method. I believe the technique is called the Modified Internal Rate of Return
(MIRR) method.
Guta: No problem. We should be able to calculate the project’s MIRR.

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Ali: Great! I would also like to see the NPV, IRR, simple payback period, and discounted payback
period results for the project.
Guta: Consider it done!

With the instructions she received from Benny Gray, Joan Hamilton immediately started to work on
the cash flow calculations using the data in Exhibit 2 to analyze the profitability of the project with the
NPV, IRR, MIRR, simple payback period, and discounted payback period methods.
Exhibit 2: The data Joan Hamilton plans to use in the calculation of the cash flows for the project and in the evaluation of its
profitability.
Cost of the new system Year 0 Year 1 Year 2 Year 3 Year 4
Invoice price of the new system 280,000
15% VAT 42,000
Shipping 18,000
Installation 25,000
Total cost of the new system depreciable basis 365,000
Amount depreciation rate 2%
Salvage value 80,000

Operating fees and cost

Number of customers - 100,000 100,000 100,000 100,000
Fees per customer - 5
Cost per customer - 3
Fees earned - 500,000
Costs - 300,000

Net Operating Working Capital (NOWC) Requirement:

Year 0 Year 1 Year 2 Year 3 Year 4
Fees Earned 500,000
NOWC (18% of sales) 90,000
CF due to NOWC requirements (90,000)

This exhibit shows the data needed to calculate the cash flows for this project. The new production system has a useful life of 4 years, a
salvage value of Br. 80,000.00 Annual fees earned and cost estimates are presented in the middle of the exhibit. The system is expected
to increase the number of customers for local money transfer services by 100,000, with average fee per customer Br. 5 and cost of Br.3
per customer. DBSC’s net operating working capital requirement, which is shown at the bottom of the exhibit, is 18% of total fees
earned in a given year..

Risk Analysis

After Guta submitted the cash flow calculations and the project profitability analysis results to Ato Ali,
they had the following conversation regarding the risk analysis for the project.
Ali: The NPV, IRR, MIRR, simple payback and discounted payback results all look promising.
However, we should also conduct a risk analysis of the project before we go ahead with it. Since the
new product will be similar to the company’s other existing products, I do not believe the new project
will change the company’s beta and its overall market risk. Therefore, it should be sufficient to
evaluate the stand- alone risk of the project. What are the techniques that we can use to assess the
stand-alone risk of a project?
Guta: Sensitivity analysis is a widely used technique to determine how much a project’s NPV will
change in response to a given change in an input variable. Input variables such as sales or the cost of
capital are often used while holding other things constant.

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Ali: The number of customers is difficult to forecast with a high degree of accuracy. Therefore, we
should conduct a sensitivity analysis with regard to possible changes in the forecasted number of
customers. It should be sufficient to evaluate the impact of an increase or a decrease of 10% in number
of customer from our base forecasted. The new system will be initially employed at about 80%
capacity with our base number of customer. Therefore, the unutilized capacity of the system should
enable us to accommodate a 10% increase in number of customers. We estimate that costs, excluding
depreciation, will be 60% of sales. We can assume that this ratio will not change with the 10%
increase or decrease the number of customers.
Guta: No problem. We can conduct a sensitivity analyses for the project’s NPV with regard to a 10%
deviation from our base number of customer forecast.
Ali: Given the current volatile financial environment, the actual WACC figure is also likely to deviate
from the expected base level. I would like to know how sensitive the project’s NPV is to an increase or
decrease of 1% in the WACC.
Guta: No problem. We should be able to conduct a sensitivity analysis for the project with regard to a
possible 1% change in the WACC. Another analysis technique for project risk widely used in practice
is scenario analysis. In this technique, the best and worst-case NPV scenarios are compared with the
projects expected NPV. Do you want us to conduct a scenario analysis of the project as well?

Ali: Yes. It would be a good idea. As the best-case scenario, assume that the number of customers
forecast will be 10% higher and the WACC will be 1% lower than our original estimates. For the
worst-case scenario, assume that the sales forecast will be 10% lower and the WACC will be 1%
higher. Please calculate the standard deviation and the coefficient of variation of the project’s NPV
probability distribution with these scenarios. You can assume a probability of 50% for the base NPV
forecast, a probability of 20% for the best-case scenario, and a probability of 30% for the worst-case
scenario.

Guta: No problem. I should be able to submit the risk analysis results to you within a week. With the
instructions she received from Ato Ali, Guta immediately started to conduct a stand-alone risk
evaluation of the project with the sensitivity analysis and scenario analysis techniques.

QUESTIONS
Assuming that you are Guta, answer the following questions:

1. Calculate Dashen’s WACC using the data in Exhibit 1.

Solution :

The weighted average cost of capital (WACC) is the rate that a company is expected to pay on average
to all its security holders to finance its assets.

The WACC is the minimum return that a company must earn on an existing asset base to satisfy its
creditors, owners, and other providers of capital, or they will invest elsewhere. Companies raise
money from a number of sources: common equity, preferred stock, straight debt, convertible

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debt, exchangeable debt, warrants, options, pension liabilities, executive stock options, governmental
subsidies, and so on. Different securities, which represent different sources of finance, are expected to
generate different returns. The WACC is calculated taking into account the relative weights of each
component of the capital structure. The more complex the company's capital structure, the more
laborious it is to calculate the WACC.

Cost of Debt:

Kd= Ir + Par v –Market v

Number of Year .
Par v + Market v
2.

Kd= 90 + (1,058.59-1,000.00) = 90.00-58.59 = 90-1.95

30 30 . 1,029.30
(1,058.59+1,000.00) 2,058.59 =88.05
2 2 1,029.30
= 0.08559
After tax
Ka = Kd(1-tax)
= 9%(1-30%)
= 0.09(1-0.3)
= 0.09(0.7)
= 0.063
= 6.3%
 Therefore, the after tax cost of DBSC new bond issue is 6.3%. that is DBSC's should be able
to earn a minimum of 6.3% to satisfy bondholders. otherwise, the firm's value will decline.

Cost of Preferred Stock:

= Dividend
Price – floatation cost .

= 9 .
102-7%
= 9 .
94.86

= 0.095
=9.5%
Cost of Preferred Stock = = 9.5%

CAMP Kc = Rf +β(Rm-Rf)
Rm-Rf= market return

= 2% + 1.2(0.06)
= 0.02+0.072
= 0.092

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 =9.2%

Discount Cash Flow = Do (1+g) + g

Po
DCF = 1 (1+5%) + 5%
19.08

= 1+0.05 + 0.05
19.08

= 1.05+0.05
19.08

= 0.055+0.05

= 0.105

= 10.5%
Own Bond yield plus Risk premium : Rs = Rd + Bond Rp
= 0.063+ 0.035
= 0.098
= 9.8%

Wd rd (1 – T) + Wps r ps + Wre rs + Wncs re = (0.3) (0.0063)+ (0.1)(0.095) + (0.6)(95,000/219,000)

(0.0983) + (0.6)(124,000/219,000)(0.1092)

WACC = 0.0189 +0.0095 + 0.0256 + 0.0371 = 9.11%

 The minimum rate of return on all projects should be 9.11% meaning, DBSC should accept all
projects so long as they earn a return greater than or equal to 9.11%.

2. Calculate the project’s cash flows using the data in Exhibit 2. Why is it important to take
into account the effect of inflation in forecasting the cash flows? Briefly comment.

Solution : Annual revenue and cost estimates (assume 3% inflation rate):

Year 1 Year 2 Year 3 Year 4

No. of Customers 100,000 100,000 100,000 100,000
Fees per customer 5.0 5.5 6.05 6.66
Cost per customer 3.0 3.3 3.63 3.99

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Fees Earned $500,000.00 $550,000.00 $605,000.00 $665,500.00
Costs 300,000.00 330,000.00 363,000.00 399,300.00

Depreciation:

SLM=Cost–Salvage Value
Economic Life
Cost =
280,000+142,000+18,000+25,000) - 80,000 = 285 285,000
= 285,00x25%
= 71,250.00

Operating cash flows:

Year 1 Year 2 Year 3 Year 4

Fees $ 500,000.00 $ 550,000.00 $ 605,000.00 $ 665,500.00
Costs 300,000.00 330,000.00 363,000.00 399,300.00
Depreciation 71,250.00 71,250.00 71,250.00 71,250.00
EBIT 128,750.00 148,750.00 170,750.00 194,950.00
Tax (30%) 38,625.00 44,625.00 51,225.00 58,485.00
NOPAT 90,125.00 104,125.00 119,525.00 136,465.00
Add Depreciation 71,250.00 71,250.00 71,250.00 71,250.00
Net Operating Cash Flow $ 161,375.00 $ 175,375.00 $ 190,775.00 $ 207,715.00

Net operating working capital (NOWC) requirement:

Year 0 Year 1 Year 2 Year 3 Year 4

Fees Earned $500,000.00 $ 550,000.00 $ 605,000.00 $ 665,500.00
NOWC (18% of fees earn) 90,000.00 99,000.00 108,900.00 119,790.00
CF due to NOWC (90,000.00) (9,000.00) (9,900.00) (10,890.00) 119,790.00

Salvage value: ($80,000.00)(1 – 0.3) = $ 56,000.00

Project net cash flows:

Year 0 Year 1 Year 2 Year 3 Year 4

Initial Investment ($365,000.00)
Operating Cash Flows $161,375.00 $175,375.00 $ 190,775.00 $ 207,715.00
CF due to NOWC (90,000.00) (9,000.00) (9,900.00) (10,890.00) 19,790.00
Salvage Cash Flow ___________ __________ __________ __________ 56,000.00
Net Cash Flows ($ 455,000.00) $ 152,375.00 $ 165,475.00 $ 179,885.00 $ 383,505.00

The discount rate generally includes an inflation premium. If the cash flows are not adjusted for inflation, the
project’s NPV would be understated.

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 3. Evaluate the profitability of the project with the NPV, IRR, simple payback period,
and discounted payback period methods. Is the project acceptable? Briefly explain.
Why is the NPV method superior to the other methods of capital budgeting? Briefly
explain.

Solution :

Once projects have been identified, management then begins the financial process of determining
whether or not the project should be pursued. The three common capital budgeting decision tools are
the payback period, net present value (NPV) method and the internal rate of return (IRR) method.

NPV

NPV = PV inflow- Initial investment

PV inflow = 152,375 + 165,475 + 179,885 + 383,505
1.0911 1.1905 1.2989 1.4173
= 139,652.64 +138,996.22+138,490.26 + 270,588.44

NPV = 687,727.57- 455,000.00

=232,727.57

If NPV>0, accept the project

NPV<0, reject the project
The project is acceptable because NPV is positive

IRR. PV (Inflows) =PV (Investment costs)

CF 1 CF 2 CF 3 CF 4
CF0 + + + +
( 1+ IRR ) 1 (1+ IRR ) 2 ( 1+ IRR ) 3 ( 1+ IRR ) 4
=0
Then after inserting the figures into the formula, the result of IRR is 27.31%

Simple Payback Period = 2.76 years

Discounted Payback Period = 3.24yr

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The NPV technique is superior to the other techniques of capital budgeting. The goal of financial management
is to maximize the market value of the firm. The NPV of a project shows the contribution of the project to the
market value of the firm. The NPV method’s reinvestment rate assumption is also more realistic compared with
the IRR method.
The goal of financial management is to maximize the market value of the firm. The NPV of a project shows the
contribution of the project to the market value of the firm.
It assumes the investment of future cash flows at the required return not at the potentially higher forecast return
for single project.
By taking in to account time value of of money.

It assumes more re-investment rate, since NPV assumes intermediary cash flows can be re invested at the firms
cost of capital.

4. Conduct the stand-alone risk analysis of the project with the sensitivity analysis and
scenario analysis techniques. Explain why sensitivity analysis and scenario analysis can
be useful tools in the capital budgeting decision-making process when economic and
financial conditions are likely to change in the future.
Solution 4: Assume that WACC is 1 percentage point higher (9.11%+1%=10.11%):
(Use the same cash flows as in Question 2 and 3 above but a higher discount rate to find the
project’s NPV.)

NPV = $214,556.14
Assume that WACC is 1 percentage point lower (9.11%-1%=8.11%): (Use the same cash
flows as in Question 2 and 3 above but a lower discount rate to find the project’s NPV. )

NPV = $248,361.24

Assume that the project’s sales revenues and costs (excluding depreciation) are 10% higher:
(Calculate new cash flows and find the NPV of the project using the base WACC calculated in
Answer 1).

Operating cash flows:

Year 1 Year 2 Year 3 Year 4
Fees Earned $550,000.00 $605,000.00 $665,500 $732,650
Costs (330,000.00) (363,000.00) (399,300) (439,230)
Depreciation (71,250) (71,250) (71,250) (71,250)
EBIT 148,750 107,750 194,950 222,170
Tax (30%) 44,625 51,225 58,485 66,651
NOPAT 104,125 119,525 136,465 155,519
Add Depreciation 71,250 71,250 71,250 71,250
Net Operating Cash Flow 175,375 190,775 207,715 226,769

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Net Operating Working Capital (NOWC)
Requirement:
Year 0 Year 1 Year 2 Year 3 Year 4
Sales 550,000 605,000 665,500 732,050
NOWC (18% of Fees) 99,000 108,900 119,790 131,769
CF due to NOWC (99,000) (9,900) (10,890) (11,979) 131,769

Project net cash flows:

Year 0 Year 1 Year 2 Year 3 Year 4
Initial Investment ($365,000)
Operating Cash Flows $175,375 $190,775 $207,715 $226,769
CF due to NOWC (99,000.00) (9,900) (10,890) (11,979) 131,769
Salvage Cash Flow ___________ __________ __________ __________ 56,000
Net Cash Flows ($455,000) $165,475 $179,885 $195,736 $414,538

NPV @ 9.11%
=165,475 + 179,885 + 195,736 + 414,538 -455,000
1.0911 1.1905 1.2989 1.4173

=290.937.22

Now, assume that the project’s sales revenues and costs (excluding depreciation) are 10% lower:
(Calculate new cash flows and find the project NPV using the base WACC calculated in Answer 1.)

Operating cash flows:

Year 1 Year 2 Year 3 Year 4
Fees Earned 450, 000 495,000 544,500 598,950
Costs (270,000) (297,000) (326,700) (359,370)
Depreciation (71,250) (71,250) (71,250) (71,250)
EBIT 108,750 126,750 146,550 168,330
Tax (30%) 32,625 38,025 43,965 50,499
NOPAT 76,125 88,725 102,585 117,831
Add Depreciation 71,250 71,250 71,250 71,250
Net Operating Cash Flow $147,375 $159,975 $173,835 $189,081

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Net Operating Working Capital (NOWC)
Requirement:
Year 0 Year 1 Year 2 Year 3 Year 4
Sales Birr 450,000 Birr 495,000 Birr 544,500 Bir598,950
NOWC (18% of sales) 81,000 89,100 98,010 107,811
CF due t (81,000) (8,100) (8,910) (9,801) 107,811

Project net cash

flows:
Year 0 Year 1 Year 2 Year 3 Year 4
Initial Investment (Birr 365,000) - - - -
Operating Cash
Flows - Birr 147,375 Birr 159,975 Birr 173,835 Birr189,081
CF due to NOWC (81,000) (8,100) (8,910) (9,801) 107,811
Salvage Cash Flow _______-____ ________-__ _______-___ _______-___ 56,000

Net Cash Flows (Birr 446,000) Birr 139,275 Birr 151,065 Birr 164,034 Birr 352,892

NPV @ 9.11%
= 139,275 + 151,065 + 164,034 + 352,892 – 446,000
1.0911 1.1905 1.2989 1.4173
= 629,814.25-446,000
=183,814.25

Best-Case Scenario: Sales revenues and costs (excluding depreciation) are 10% higher, and WACC is
1 percentage point lower. (Student uses the cash flows calculated above with 10% higher revenues,
10% higher costs, and discounts these cash flows to the present by using 8.11%.

Year 0 Year 1 Year 2 Year 3 Year 4

Cash Flows: (Birr 455,000) Birr 165,475 Birr 179,885 Birr 195,736 Birr 414,538

NPV @ 8.11%
=165,475 + 179,885 + 195,736 + 414,538 – 455,000
1.0811 1.1878 1.26357 1.36604
= 307,872.31

Worst-Case Scenario: Sales revenues and costs (excluding depreciation) are 10% lower, and WACC is
1 percentage point higher. (Student uses the cash flows calculated above with 10% lower revenues,
10% lower costs, and discounts these cash flows to the present by using WACC of 18.09%

Year 0 Year 1 Year 2 Year 3 Year 4

(Birr 446,000) Birr 139,275 Birr 151,065 Birr 164,034 Birr 352,892

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Cash Flows:

NPV @ 10.11%
= 139,275 + 151,065 + 164,034 + 352,892 – 446,000
1.1011 1.2124 1.3445 1.46997
= 613,158.32-446,000
=167,158.32

E (NPV) = (0.3)(Birr 167,158.32+ (0.5)(Birr 232,727.57) + (0.2)(Birr 307,872.31)

= 50,147.50 + 116,363.78 + 61,574.46
= Birr 228,085.74
σNPV = [(Birr 167,158.32 – Birr 228,085.74)2 (0.3) + (Birr 232,727.57 –Birr 228,085.74)2 (0.5)
+ (Birr 307,873.31 – Birr 228,085.74)2 (0.2)]1/2
= 65,598.30

CV NPV = Birr 228,085.74 = 3.48

Birr 65,598.30

Sesitivity analaysis and scenario analyisis can be useful tools in the capital budgeting decision making
process when economic and financial conditions are likely to change in the future.

CONCULUSION

Capital bud- getting decisions can be separated crudely into “Yes–No” decisions (“Should we
undertake a given project?”) and into “ranking” decisions (“Which of the following list of projects do
we prefer?”).

The difference between NPV and IRR in making the capital budgeting decision. In many cases these
two criteria give the same answer to the capital budgeting question. However, there are cases—
especially when we rank projects—where NPV and IRR give different answers. Where they differ,
NPV is the preferable criterion to use because the NPV is the additional wealth derived from a project.

Financial Management Assignment 13| P a g e