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FV
(1+R)N
PV of year 1 CF :
PV of year 3 CF :
PV of year 3 CF :
1200
(1+.1)1
2400
(1+.1)3
2600
(1+.1)4
Tk. 1,090.91
Tk. 1,803.16
Tk. 1,775.83
Page 1
Project A:
Pay Back Period
(PBP)
NCO-C
D
A+
1+
Here,
1.875 years
Project B:
Year
1
2
3
Pay Back Period
(PBP)
= A+
NCO-C
D
= 2+
Tk. 12,000-Tk.
11,000
Tk. 5,000
C2
+
(1+R)N1
Tk. 6.500
-Tk. 139.72
5,652
(1+R)N2
Tk. 4,000
+
(1+.15)1
C3
(1+.15)2
3,025
Here,
(1+R)N3
NCO
Tk. 10,000
R=Interest Rate/Discount
Rate
Tk. 10000
N=Number of years
NCO=Net cash
outflow/Initil Investment
Tk. 1,800
+
(1+.15)3
1,184
C= Cash Flow
Project B:
C1
Net Present
Value (NPV)
(1+R)N1
Tk.
7,000
C2
+
(1+.15)1
=
6087
(1+R)N2
Tk.
4,000
C3
+
(1+.15)2
+
3025
(1+R)N3
Tk.
5,000
(1+.15)3
] -
NCO
] -
Tk.
12,000
3288 ] - 12000
Here,
NCO=Net cash
outflow/Initial
Investment
C= Cash Flow
R=Interest
Rate/Discount Rate
N=Number of years
Page 2
= 399.11
So, the firm should choose Project B since it has a higher NPV than Project A has.
4. Calculating IRR Teddy Bear Planet, Inc., has a project with the following cash flows:
Year
Cash Flow (Tk.)
0
-11,000
1
5,500
2
4,000
3
3,000
The company evaluates all projects by applying the IRR rule. If the appropriate interest rate is 8 Percent,
should the company accept the project?
Sol.
C1
Net Present
Value (NPV)
C2
(1+R)1
Tk.5,500
=
+
(1+.08)1
= [ 5093
= Tk. -97
(1+R)2
Tk.
4,000
C3
+
(1+R)3
Tk.
3,000
(1+.08)2
+
3429
] -
NCO
] -
Tk.
11,000
(1+.08)3
2381 ] - 11000
Here,
NCO=Net cash
outflow/Initil
Investment
C= Cash Flow
R=Interest
Rate/Discount Rate
N=Number of years
=
=
IRR
[
Tk. 268
A+
.06+
.06+
7.47%
C1
(1+R)1
Tk.5,500
(1+.06)1
5189
C
C-D
Tk. 268
Tk.268-(-Tk 97)
Tk. 268
Tk.268+Tk 97)
+
+
+
C2
+
(1+R)2
Tk. 4,000
+
(1+.06)2
3560
+
(B-A)
(.08-.06)
x0.02
C3
(1+R)3
Tk. 3,000
(1+.06)3
NCO
Tk. 11,000
2519 ]
Tk. 11000
Here,
A= Lower interest Rate
B= Higher interest rate
C= NPV of lower interest rate
D= NPV of higher interest rate
Page 3
5. Calculating Profitability Index Bill plans to open a self-serve grooming centre in a storefront. The
grooming equipment will cost $190,000, to be paid immediately. Bill expects after tax cash inflows
of $65,000 annually for seven years, after which he plans to scrap the equipment and retire to the
beaches of Nevis. The first cash inflow occurs at the end of the first year. Assume the required return
is 15 percent. What is the projects PI? Should it be accepted?
Sol.
The profitability index is defined as the PV of the cash inflows divided by the PV of the cash outflows.
The cash flows from this project are an annuity, so the equation for the profitability index is:
Here,
1
A{1}
N
PVA
=
A=Tk. 65000
(1+R)
R
R= 15% = 0.15
N= 5 Years
1
Tk. 65,000{1}
5
=
(1+.15)
0.15
Tk. 32,684
=
0.15
Tk. 217,890
=
Profitability
Index (PI)
=
=
Tk. 217,890
Tk. 190,000
1.15
Dt (1 + g)
(R g)
Here,
Pt=
Dt=
R=
g=
Price of stock
Estimated dividend for next year
Required rate of return
Growth rate
P0 =
D0 (1 + g)
(R g)
= Tk. 5 (1 + .05)
Here,
P0= Tk. 5
D0= 1 years
Page 4
(.12 .05)
R= 12 % = 0.12
g= 5 % = 0.05
= Tk. 75
Here,
Present Value (PV)= Tk. 75
R= 5 % = 0.05
N= 3 years
Future Value (FV)= ?
PV (1+R)N
= Tk. 75 (1+ .05)3
= Tk. 86.82
FV= PV (1+R)
= Tk. 75 (1+ .05)15
= Tk. 155.92
7. Yield on a Zero under Real-World Convention of Semi annually Compounding Suppose the EightInch Nails (EIN) Company issues a Tk. 1,000 face value, five years zero coupon bond. The initial
price is set Tk. 500. What is the yield to maturity using semi annual compounding?
Here,
FV= Tk. 1,000
PV= Tk. 500
N=5 years
R= ?
We know that,
=>
=>
=>
=>
FV
PV (1+R)N
Tk. 1,000
Tk. 1,000
Tk. 1,000
Tk. 1,000
Tk. 500
=
=
=
Tk. 500(1+R/2)Nx2
Tk. 500(1+R/2)5x2
Tk. 500(1+R/2)10
2+ R
)10
2
2+ R
)10/10
2
2+ R
2
1.07 x 2
2.14 -2
0.14
14%
(
(
=>
21/10
=>
1.07
=>
=>
=>
=>
2+ R
R
R
R
=
=
=
=
Page 5