Math Problem Solver

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MINICASE

Aman Limited is a leading manufacturer of automotive components. It supplies to the original equip-

ment manufacturers as well as the replacement market. Its projects typically have a short life as it

introduces new models periodically.

You have recently joined Aman Limited as a financial analyst reporting to Ravi Sharma, the CFO of

the company. He has provided you the following information about three projects, A, B, and C that are

being considered by the Executive Committee of Aman Limited:

Project A is an extension of an existing line. Its cash flow will decrease over time.

Project B involves a new product. Building its market will take some time and hence its cash flow

will increase over time.

Project C is concerned with sponsoring a pavilion at a Trade Fair. It will entail a cost initially

which will be followed by a huge benefit for one year. However, in the year following that some

cost will be incurred to raze the pavilion.

The expected net cash flows of the three projects are as follows.

Project B

(Rs.)

(15,000)

3,500

8,000

13,000

Ravi Sharma believes that all the three projects have risk characteristics similar to the average risk of

the firm and hence the firm's cost of capital, viz. 12 percent, will apply to them.

You have been asked to prepare a report for the executive committee, covering the following:

(a) What is payback period and discounted payback period? Find the payback period and the dis-

counted payback period of Projects A and B.

(b) What is net present value (NPV)? What are the properties of NPV? Calculate the NPV of projects

A, B, and C.

(c) What is internal rate of return (IRR)? What are the problems with IRR? Calculate the IRR for

Projects A, B, and C.

Project A

(Rs.)

(15,000)

11,000

7,000

4,800

Project C

(Rs.)

(15,000)

42,000

(4,000)