Walks Softly sells customized shoes.

Currently, it sells 14,800 pairs of shoes

annually at an average price of $59 a pair. It is considering adding a lower-
priced line of shoes that will be priced at $39 a pair. Walks Softly estimates it
can sell 6,000 pairs of the lower-priced shoes but will sell 3,500 less pairs of the
higher-priced shoes by doing so. What annual sales revenue should be used
when evaluating the addition of the lower-priced shoes?

Case 1
Shoes sold annually 14800
Average Price $ 59.00
Annual Sales Revenue $ 873,200.00

Case 2
Average Price $ 39.00
Lower Priced Shoes Sales 6000
Higher Priced Shoes Sales 11300
Annual Sales Revenue $ 900,700.00

Hence, the annual sales revenue to be used when evaluating the addition of the lower-priced shoes is $900,700.
mid-range camper and expects that if she does so she can sell 1,500 of them.
However, if the new camper is added, Jamie expects that her Class A sales will
decline to 850 units while the Class C camper sales decline to 2,000. The sales of
pop-ups will not be a_x000B_ected. Class A motor homes sell for an average of
$140,000 each. Class C homes are priced at $59,500 and the pop-ups sell for $5,000
each. The new mid-range camper will sell for $42,900. What is the erosion cost of
adding the mid-range camper?

Current Sales of Class A motor homes 1100

Current Sales of Class C motor homes 2200
Current Sales of pop-up trailers 2800
Selling Price of Class A motor homes $ 140,000.00
Selling Price of Class C motor homes $ 59,500.00
Selling Price of pop-up trailers $ 5,000.00
Current Total Sales $ 298,900,000.00

Sales from mid-range camper (if added) 1500

New Sales of Class A motor homes 850
New Sales of Class C motor homes 2000
New Sales of pop-up trailers 2800
Selling Price of mid-range camper $ 42,900.00
Total sales if mid-range camper is added $ 252,000,000.00
Erosion Cost $ 46,900,000.00
Peter's Boats has sales of $760,000 and a net profit margin of 5
percent. The annual depreciation expense is $80,000. What is the
amount of the operating cash flow if the company has no long-term
debt and no working capital expense?

Sales $ 760,000.00
Annual Depreciation $ 80,000.00
Profit Margin 5%

PAT 38,000
(+) Depreciation 80,000

Operating Cash Flow $118,000

Thornley Machines is considering a 3-year project with an initial cost for fixed
assets of $618,000. The project will reduce operating costs by $265,000 a year. The
equipment will be depreciated straight-line to a zero book value over the life of the
project. At the end of the project, the equipment will be sold for an estimated
$60,000. The tax rate is 34 percent. The project will require $23,000 in extra
inventory over the project's life. What is the NPV if the discount rate assigned to
the project is 14 percent?
Year 0
Investment $ 618,000.00 Depreciation
Useful life 3 years EOY BV $ 618,000.00
Savings $ 265,000.00
Salvage Value $ 60,000.00 Proforma Income Statement
Tax Rate 34% Savings
Discount Rate 14% Depreciation
Extra Investment $ 23,000.00 EBIT
Depreciation SLM to Zero PAT

Operating Cash Flow

PAT
Depreciation
Delta NWC $ (23,000.00)
OCF $ (23,000.00)

Free Cash Flow

Investment $ (618,000.00)
Salvage Value
SVT
FCF $ (641,000.00)

NPV $ (30,086.23)
 1 2 3
$ 206,000.00 $ 206,000.00 $ 206,000.00
$ 412,000.00 $ 206,000.00 $ -

Proforma Income Statement

$ 265,000.00 $ 265,000.00 $ 265,000.00
$ 206,000.00 $ 206,000.00 $ 206,000.00
$ 59,000.00 $ 59,000.00 $ 59,000.00
$ 38,940.00 $ 38,940.00 $ 38,940.00

Operating Cash Flow

$ 38,940.00 $ 38,940.00 $ 38,940.00
$ 206,000.00 $ 206,000.00 $ 206,000.00
$ 23,000.00
$ 244,940.00 $ 244,940.00 $ 267,940.00

Free Cash Flow

$ 60,000.00
$ (20,400.00)
$ 244,940.00 $ 244,940.00 $ 307,540.00
Matty's Place is considering the installation of a new computer system that will
cut annual operating costs by $12,000. The system will cost $42,000 to purchase
and install. This system is expected to have a 5-year life and will be depreciated
to zero using straight-line depreciation. What is the amount of the earnings
before interest and taxes for each year of this project?
Year 0 1
Investment $ 42,000.00 Depreciation $ 8,400.00
Useful life 5 years EOY BV $ 42,000.00 $ 33,600.00
Savings/year $ 12,000.00
Depreciation SLM to Zero Proforma Income Statemen
Savings $ 12,000.00
Depreciation $ 8,400.00
EBIT $ 3,600.00
 2 3 4 5
$ 8,400.00 $ 8,400.00 $ 8,400.00 $ 8,400.00
$ 25,200.00 $ 16,800.00 $ 8,400.00 $ -

Proforma Income Statement

$ 12,000.00 $ 12,000.00 $ 12,000.00 $ 12,000.00
$ 8,400.00 $ 8,400.00 $ 8,400.00 $ 8,400.00
$ 3,600.00 $ 3,600.00 $ 3,600.00 $ 3,600.00
Tool Makers manufactures equipment for use by other firms.
The initial cost of one customized machine is $850,000 with an
annual operating cost of $10,000, and a life of 3 years. The
machine will be replaced at the end of its life. What is the
equivalent annual cost of this machine if the required rate of
return is 15 percent and we ignore taxes?

Investment $850,000
Operating cost $10,000
life 3
Discount rate 15%

Year 0 1 2 3
CF $850,000 $10,000 $10,000 $10,000
NPV $872,832
Equivalent annual cost $382,280
Kay's Nautique is considering a project which will require additional
inventory of $128,000 and will also increase accounts payable by $45,000.
Accounts receivable are currently $80,000 and are expected to increase by
10 percent if this project is accepted. What is the initial project cash flow
needed for net working capital?

Inventory $128,000
Accounts payable $45,000
Account receivable $80,000
Increased percentage 10%
Increased Accounts receivable $8,000
Project cash flow needed for NWC $91,000
Tech Enterprises is considering a new project that will require $325,000 for fixed assets, $160,000 for
inventory, and $35,000 for accounts receivable. Short-term payables is expected to increase by $100,000.
The project has a 5-year life. The fixed assets will be depreciated straight-line to a zero book value over
the life of the project. At the end of the project, the fixed assets can be sold for 25 percent of their
original cost and the net working capital will return to its original level. The project is expected to
generate annual sales of $554,000 and costs of $430,000. The tax rate is 35 percent and the required rate
of return is 15 percent. What is the net present value of this project?

Fixed assets $325,000

Inventory $160,000
Accounts receivable $35,000
Short term payables $100,000
Total Initial Investment -$420,000
Depreciation Straight line method
Salvage value $81,250
Revenue $554,000
Cost $430,000
Tax rate 35%
Discount rate 15%
Year 0 1 2 3 4 5 Year 0 1
Depreciation 65000 65000 65000 65000 65000 BOY NWC $95,000
Book value $325,000 $260,000 $195,000 $130,000 $65,000 $0 EOY NWC $95,000 $95,000
Delta NWC -$95,000 $0
Revenue $554,000 $554,000 $554,000 $554,000 $554,000
Cost $430,000 $430,000 $430,000 $430,000 $430,000
EBITDA $124,000 $124,000 $124,000 $124,000 $124,000
Depreciation 65000 65000 65000 65000 65000
EBIT $59,000 $59,000 $59,000 $59,000 $59,000
Taxes 20650 20650 20650 20650 20650
PAT $38,350 $38,350 $38,350 $38,350 $38,350

Cash flow statement

PAT $38,350 $38,350 $38,350 $38,350 $38,350
Depreciation 65000 65000 65000 65000 65000
Delta NWC -$95,000 $0 $0 $0 $0 $95,000
OCF -95000 $103,350 $103,350 $103,350 $103,350 $198,350

Investment -$325,000
Salvage value $81,250
Salvage value tax -28437.5
FCF -420000 $103,350 $103,350 $103,350 $103,350 $251,163
NPV -65.83
 2 3 4 5
$95,000 $95,000 $95,000 $95,000
$95,000 $95,000 $95,000 0
$0 $0 $0 $95,000
The Down Towner is considering a 4-year project that will require $164,800 for
Fixed assets and $42,400 for net working capital. The fixed assets will be
depreciated straight-line to a zero book value over the life of the project. At the end
of the project, the fixed assets can be sold for $37,500 and the net working capital
will return to its original level. The project is expected to generate annual sales of
$195,000 and costs of $117,500. The tax rate is 35 percent and the required rate of
return is 13 percent. What is the project's net present value?

Investment $164,800
Net working capital $42,400
Salvage value $37,500 Year 0
Revenue $195,000 Depreciation
Cost $117,500 Book value $164,800
Tax rate 35%
Discount rate 13% Revenue
cost
EBITDA
Depreciation
EBIT
Taxes
PAT

Cash flow statement

PAT
Depreciation
Delta NWC -$42,400
OCF -42400

Investment -$164,800
Salvage value
Salvage value tax
FCF -207200
NPV 26485.23
 Year 0 1 2 3 4
1 2 3 4 BOY NWC $42,400 $42,400 $42,400 $42,400
41200 41200 41200 41200 EOY NWC $42,400 $42,400 $42,400 $42,400 0
$123,600 $82,400 $41,200 0 Delta NWC -$42,400 $0 $0 $0 $42,400

$195,000 $195,000 $195,000 $195,000

$117,500 $117,500 $117,500 $117,500
$77,500 $77,500 $77,500 $77,500
41200 41200 41200 41200
$36,300 $36,300 $36,300 $36,300
12705 12705 12705 12705
$23,595 $23,595 $23,595 $23,595

$23,595 $23,595 $23,595 $23,595

41200 41200 41200 41200
$0 $0 $0 $42,400
$64,795 $64,795 $64,795 $107,195

$37,500
-13125
$64,795 $64,795 $64,795 $131,570
Lew's Market invested in a project that returned 16.67 percent
during a period when inflation averaged 3.26 percent. What real
rate of return did Lew's earn on its project?

Rate of return 16.67%

Inflation 3.26%
Real rate of return 12.99%
You are working on a bid for a contract. Thus far, you have
determined that you
will need $156,000 for fixed assets and another $32,000 for
net working capital at
Time 0. You have also determined that you can recover
$68,400 aftertax for the
combined
Assumption: fixed
NWCassets and net working
is recovered capital
at the end at the end of
of 4 years PAT 39551.380835
the 4-year project.
PAT
What= operating
Bid price cash flow will be required each year for the NWC
project to return 16 Year 0 1 2 3 4
percent in nominal terms? BOP BV 32000 32000 32000 32000
EOP BV 32000 32000 32000 32000 0
NWC -32000 0 0 0 32000

OCF
PAT 39551.38 39551.38 39551.38 39551.38 39551.38
NWC -32000.00 0.00 0.00 0.00 32000.00
Salvage value 36400.00
OCF 7551.38 39551.38 39551.38 39551.38 107951.38

Investment -156000.00

FCF -148448.62 39551.38 39551.38 39551.38 107951.38

NPV 0.00
In working on a bid project you have determined that $318,000 of fixed assets will
be required and that they will be depreciated straight-line to zero over the 6-year
life of the project. You have also determined that the discount rate should be 18
percent and the tax rate will be 35 percent. In addition, the annual cash costs will
be $198,200.
Fixed Assets After considering all of the project's cash flows you have determined 318000
that the required operating cash flow is $92,400. What is the amount of annual
SLM
salesDepreciation
revenue that is required? 6
Discount Rate 18%
Tax Rate 35%
92400
Revenue 311815.384615385
Depreciation
Year 0 1 2 3
BOP BV 318000 318000 265000 212000
Depreciation 53000 53000 53000
EOP BV 318000 265000 212000 159000

Proforma Income Statement

Revenue 311815.38 311815.38 311815.38
Cash Costs 198200.00 198200.00 198200.00
EBITDA 113615.38 113615.38 113615.38
Depreciation 53000.00 53000.00 53000.00
EBIT 60615.38 60615.38 60615.38
PAT 39400.00 39400.00 39400.00

OCF
PAT 39400.00 39400.00 39400.00
Depreciation 53000.00 53000.00 53000.00
Total OCF 92400.00 92400.00 92400.00

Investment -318000

FCF -318000 92400.00 92400.00 92400.00

NPV $5,178.48
 4 5 6
159000 106000 53000
53000 53000 53000
106000 53000 0

311815.38 311815.38 311815.38

198200.00 198200.00 198200.00
113615.38 113615.38 113615.38
53000.00 53000.00 53000.00
60615.38 60615.38 60615.38
39400.00 39400.00 39400.00

39400.00 39400.00 39400.00

53000.00 53000.00 53000.00
92400.00 92400.00 92400.00

92400.00 92400.00 92400.00

A $218,000 project has equal annual cash flows over its 7-year life. If the discounted
payback period is seven years and the discount rate is 0%, what is the amount of Year
the cash
Using PMTflow in each
formula forofEAI
the seven years? Cashflows
IRR
 0 1 2 3 4 5
-218000 ₹31,142.86 ₹31,142.86 ₹31,142.86 ₹31,142.86 ₹31,142.86
0%
 6 7
₹31,142.86 ₹31,142.86
A proposed new venture will cost $175,000 and should produce annual cash
flows of $48,500, $85,000, $40,000, and $40,000 for Years 1 to 4, respectively. The required
payback period and discounted payback period is 3 years. The discount rate is 9
Considering onlymethods
percent. Which payback indicate
period orproject
discounted payback
acceptance of which
and 3 yearsindicate
will leadproject
to rejection of both the
Year
project
rejection?
Actual break even occurs between 3 to 4 years CF
Discount Rate
PV - 3 Years
NPV - 3 years
IRR - 3 years

PV - 4 Years
NPV - 4 years
IRR - 4 years

Profitability Index - 3 years

Profitability Index - 4 years
 0 1 2 3 4
-175000 48500 85000 40000 40000
9%
₹146,925.55
-28074.45
-0.440%

₹175,262.56
262.56
9.073%

0.84
₹1.00
Project A has an initial cost of $75,000 and annual cash flows of $33,000 for three
years. Project B costs $60,000 and has cash flows of $25,000, $30,000, and $25,000
for Years 1 to 3, respectively. Projects A and B are mutually exclusive. What is the
incremental
NPV assumedIRR?zeroIf the required rate is higher than the crossover rate then which
project should be accepted?
NPV at 10%

Based on IRR, project B gives the higher IRR, but the difference between the IRRs of the two projects is
not
Crossover rate is between 15-16%
Incremental IRR is lower than individual IRRs.
Project A
Year 0 1 2 3
CF -75000 33000 33000 33000
NPV-A (0%) $24,000.00
NPV-A (13%) 2918.036
IRR-A 15.28%

Project B
Year 0 1 2 3
CF -60000 25000 30000 25000
NPV-B (0%) $20,000.00
NPV-B (13%) 2944.548
IRR-B 15.86%

Incremental CF A vs B
Year 0 1 2 3
CF -15000 8000 3000 8000
NPV-A-B (0%) 4000.000
NPV-A-B (10%) 762.585
NPV-A-B (12%) 228.681
IRR-A-B 12.89%
Discount Rate NPV-A NPV-B
0% 24000.00 20000.00
1% 22052.51 18426.11
2% 20168.15 16902.93
3% 18344.17 15428.26
4% 16578.00 14000.06
5% 14867.18 12616.35
6% 13209.39 11275.28
7% 11602.43 9975.09
8% 10044.20 8714.12
9% 8532.72 7490.77
10% 7066.12 6303.53
11% 5642.59 5150.98
12% 4260.43 4031.75
13% 2918.04 2944.55
14% 1613.86 1888.14
15% 346.43 861.35
16% -885.65 -136.95
17% -2083.70 -1107.81
18% -3248.99 -2052.25
19% -4382.75 -2971.26
20% -5486.11 -3865.74
Kali’s Ski Resort, Inc. stock is quite cyclical. In a boom economy, the stock is expected to
return 30 percent in comparison to 12 percent in a normal economy and a negative 20
percent in a recessionary period. The probability of a recession is 15 percent while there is a
30 percent chance of a boom economy. The remainder of the time, the economy will be at
normal levels. What is the standard deviation of the returns?

Probability of event
Scenario P(x)
Boom 0.3
Recession 0.15
Normal 0.55
Predicted return from event Expected value
x x*P(x) x–μ (x – μ)^2 ((x – μ)^2)*P(x)
30% 0.09 17.400% 3.0276% 0.0090828
-20% -0.03 -32.600% 10.6276% 0.0159414
12% 0.07 -0.600% 0.0036% 1.98E-05
μ 12.60% Variance 0.025044
Std. Dev 15.83%
A portfolio consists of Stocks A and B and has an expected return of 11.6
percent. Stock A has an expected return of 17.8 percent while Stock B is
expected to return 8.4 percent. What is the portfolio weight of Stock A?

Stock A:
Expected return 17.80%
Let portfolio weight of Stock A be a
17.8a

Stock B:
Expected return 8.40%
Let portfolio weight of Stock A be 100-a
840-8.4a

Expected return of combined portfolio 11.60%

(17.8a+840-8.4a)/100 =11.6
9.4a=320
a = 320/9.4 = 34.04%

Portfolio Weight of Stock A =34.04%

There is a 20 percent probability the economy will boom, 70 percent probability it will be normal, and a 10 percent probability of a recession. Stock A will return
18 percent in a boom, 11 percent in a normal economy, and lose 10 percent in a recession. Stock B will return 9 percent in boom, 7 percent in a normal
economy, and 4 percent in a recession. Stock C will return 6 percent in a boom, 9 percent in a normal economy, and 13 percent in a recession. What is the
expected return on a portfolio which is invested 20 percent in Stock A, 50 percent in Stock B, and 30 percent in Stock C?

Returns of stock
State of Economy Probability Stock A Stock B Stock C
Boom 20.00% 18% 9% 6%
Normal 70.00% 11% 7% 9%
Recession 10.00% -10% 4% 13%
20% 50% 30%
State of Economy Weights
Boom 0.099
Normal 0.084
Recession 0.039
Portfolio expected return 8.25%
 n. Stock A will return
in a normal
on. What is the
Q19. A portfolio has 38 percent of its funds invested in Security C and 62 percent invested in Security D. Security C has an expected return of
8.47 percent and a standard deviation of 7.12 percent. Security D has an expected return of 13.45 percent and a standard deviation of 16.22
percent. The securities have a coe_x000E_cient of correlation of .89. What are the portfolio rate of return and variance values?

Security Percentage invested (weights) Expected Rate of Return Standard Deviation

C 38% 8.47% 7.12%
D 62% 13.45% 16.22%

Coefficient of correlation 0.89

Expected portfolio rate (weight o 11.56%

Variance of the portfolio 1.57%
recession. Stock T is expected to return 4 percent in a
boom, 6 percent in a normal economy, and 9 percent in a
recession. There is a 10 percent probability of a boom
and a 25 percent probability of a recession. What is the
standard deviation of a portfolio which is comprised of
$4,500 of Stock S and $3,000 of Stock T?
Stock S
Economy status Return Probability DeviationSquared deviation
Boom 12% 10% 4.45% 0.0020
Normal 9% 65% 1.45% 0.0002
Recession 2% 25% -5.55% 0.0031

Particulars Stock S Stock T

Value 4500 3000
Expected return 7.55% 6.55%
Variance 0.11% 0.02%
Standard deviation 3.32% 1.53%
Weight 0.6 0.4

Portfolio values
Covariance -0.05%
Correlation -0.99
Standard deviation 1.39%
 Stock T
Economy status Return Probability Deviation Squared deviation Covariance
Boom 4% 10% -2.55% 0.0007 -0.11%
Normal 6% 65% -0.55% 0.0000 -0.01%
Recession 9% 25% 2.45% 0.0006 -0.14%
 If the past 10 monthly returns of an Asset A are 2.5%, 2%, 4%, 3.2%, 1.7%, 0.7%,-1.4%, -1.35%, 0.2%,
and 0.75%, and the last 10 monthly returns of the market are 1.75%, 1.4%, 2.75%, 1.8%, 1.2%, 0.9%,
-0.85%, -0.9%, 0.5%, and 1.2%. Compute the beta of the Asset A from rst principle using the formula
that Beta = Covariance(Asset A, Market)/Variance(Market). Note, beta has to be estimated using
the formula and not excel.

Asset A Market (x-mean(x)) x (m-

Asset A (x) Market (m) (m-
(x-mean(x)) (m-mean(m)) Mean(m))2
2.50% 1.75% 1.27% mean(m))
0.78% 0.0098% 0.0060%
2% 1.40% 0.77% 0.43% 0.0033% 0.0018%
4% 2.75% 2.77% 1.78% 0.0492% 0.0315%
3.20% 1.80% 1.97% 0.83% 0.0163% 0.0068%
1.70% 1.20% 0.47% 0.23% 0.0011% 0.0005%
0.70% 0.90% -0.53% -0.07% 0.0004% 0.0001%
-1.40% -0.85% -2.63% -1.83% 0.0480% 0.0333%
-1.35% -0.90% -2.58% -1.88% 0.0484% 0.0352%
0.20% 0.50% -1.03% -0.48% 0.0049% 0.0023%
0.75% 1.20% -0.48% 0.23% -0.0011% 0.0005%
SUM 12.30% 9.75% 0.18% 0.12%

Expected value of Asset A 1.230% mean(x)

Expected value of Market M 0.975% mean(m)
Covariance 0.020% (0.18%/9)
Variance of Market 1.145% sqrt ( 0.12% /9)

Beta 1.53 ( Covariance / Std. Deviation2)

You were expected to compute an adequate cost of capital for your firm. The firm is an all equity
firm which is listed in the market. After considerable effort, you arrived at the beta estimate of your
firm, which is 1.5. The risk free rate after checking with your other colleagues was taken as 6 percent.
The market risk premium was 7 percent. You computed the expected return of the firm as
16.5 percent. Suddenly at the end of the day, the manager comes in and asks you to re-evaluate
the cost of capital with the following two information. She expects an announcement by the
RBI that will drop the nominal benchmark rate by 100 bps to boost the muted demand. The second
input she gave you was that the overall risk aversion in Indian market has gone up by 150 bps. Based
on these two inputs, what would be your new estimate of the cost of capital of this firm ?

Beta 1.5
Given, free rate 6% ( rfree)
Market Risk Premium 7% (rm - rfree)
Expected Returm of the Asset ( r free)+ beta x (rm- rfree) 16.5 %
Revaluation of the cost of capital
Free rate 5% Decrease- 100 bips
Market Risk Premium 8.5 % Increase- 150 bips
Expected Returm of the Asset ( r free)+ beta x (rm- rfree) 17.75 %
In the beginning of January 2025, a start-up firm founded in 2022 by ve students from the PGPBL
batch at IIMK is considering a 3-year project with an initial cost for fixed assets of 1.6 crores.
The project will reduce current operating costs by 50 lakhs a year. The equipment will be
depreciated straight-line to 10 lakhs book value at the end of 3 years. At the end of the
project, the equipment will be sold for an estimated 30 lakhs. The tax rate is 25 percent. The
project will require an initial investment of |10 lakhs in accounts receivables(a current asset) and
will be recovered by the end of the project's life. What is the NPV (in the beginning of year 2025)
if the discount rate assigned to the project is 10 percent? Will you accept this project in the
beginning of 2025?

Investment 1.6 crores

Depreciation to 0.1 crores
Savings 0.5 crores
Salvage Value 0.3 crores
Working Capital 0.1 crores

Year 0 1 2 3
Depre 0.5 0.5 0.5
EOY BV 1.6 1.1 0.6 0.1

Income Statement
Savings 0.5 0.5 0.5
Dep 0.5 0.5 0.5
PAT 0 0 0

Cash Flow Statement

PAT 0 0 0
Depre 0.5 0.5 0.5
NWC -0.1 0.1

Investing Activities
Investment -1.6
Salvage 0.3
Salvage Tax -0.05

Total Cash flows

-1.7 0.5 0.5 0.85
NPV at 2025 ₹ -0.19 crores (Reject the Project)
LUMA dairy, a start-up, did a market research and found that there is huge de- mand for dairy
products in India, but the market is under-served. The management of LUMA is also pretty condent
that it is less likely for India to sign the RCEP with countries in Asia-Pac region and hence there is
no threat to the firm's going concern status. Otherwise, dairy products from New Zealand would have
given stiff competition to Indian products and would have threatened the projected margins of LUMA.
In addition, the new corporate tax regime has slashed the corporate income tax for new companies
to 15%. The investors of LUMA is expecting a return of 15% on the investment. LUMA has two
options in terms of the equipment used for the pasteurisation process. One, a German made
machine that costs 500 crores and has a useful life of 2 years. The post-tax operating costs (including
depreciation tax shield) of the German machine is 150 and 200 crores respectively for the two years.
The second is a Japanese machine that costs 700 crores and has a useful life of 3 years.
The pre-tax operating costs (excluding depreciation) of the Japanese machine is 100, 150
and 200 crores respectively for the three years. Both machines are depreciated to zero using
straight-line method. LUMA has approached IIMK as part of the student consulting program
and this problem was assigned to FAMV students. Which machine should LUMA dairy choose ?
During the session, you have been taught the present value of the annuity factor formula and you are
contemplating to apply that learning in this question.

German Made Machine

Investment 500 Crores
Life 2 years

Year 0 1 2
Depreciation 250 250
EOY BV 500 250 0

OCF -150 -200 (Given)

Investing -500

-500 -150 -200

NPV ₹ -781.66 ( Discount Rate = 15%)
PVAF 1.62570888
EAC -480.813953 Crores (NPV / PVAF)

Japanese made machine

Investment 700 crores
Life 3 years

year 0 1 2 3
Depreciation 233.33 233.33 233.33
EOY BV 700 466.67 233.33 0.00

Costs 100 150 200 (Given)

Depreciation 233.33 233.33 233.33
PAT -283.33 -325.83 -368.33

Cash Flow Statement

PAT -283.33 -325.83 -368.33
Depreciation 233.33 233.33 233.33

OCF -50.00 -92.50 -135.00

Investing -700

Cash flows -700 -50.00 -92.50 -135.00

NPV ₹ -902.19 ( Discount Rate = 15%)
PVAF 2.283
EAC -395.137 Crores

LUMA should select Japanese made machine due to least Annual Cost
Miranda, a project manager, wants to invest in a project with an initial cost of 60 million and cash
inflows of 32 million and 39 million in the rst and second year. She has been told by the management
that the minimum required rate of return is 10%. In addition, she has been told that for every 1
invested, the firm expects a return of 1.10 in present value terms. Is this project the right choice for Miranda?

Investment 60 million
Cash in flow for 1st year 32 million
Cash in flow for 2nd year 39 miilion
Minimum rate of interest 10 %
Min expected return of Rs.1 is Rs.1.1 1.1
Min expectedreturn of 60 million 66 million

year 0 1 2
cash -60 32 39
IRR 11.58%

As it is a investment, rate of return,r is less than IRR

Rate of return 10% (considered to max Present Value)

year 0 1 2
cash -60 32 39
PV 61.32 < 66
(The project is not the right choice for Miranda)
You have been approached by a fund manager. The fund manager was trying to
divert discussion around the topic of risk whenever you asked him on the standard
deviation of their fund returns. He was using a lot of jargons during the discussion.
In between the discussion, the fund manager mentioned that their portfolio delivers
superior Sharpe ratio and it is around 0.8. You were earlier told by the fund manager
that the expected return on their portfolio is 16 percent. While he was talking, you
checked up the web and found that the risk free rate is 6.5 percent. You shocked
him when you told him that the standard deviation of the portfolio was Y percent.
What is Y?

Sharpe Ratio 0.8

Expected return (Er) 16%
Risk Free (Rf) 6.50%

Sharpe Ratio (Er- Rf)/s

Std (s) 11.88%
The expected dividend in the coming year is INR 11 and the expected subsequent
dividend growth is 6% per annum. The company is expected to pay these dividends
in perpetuity. The current share price of a firm that you are tracking is INR 50
per share. You go back to basics and look at this firm's returns over the past 5
years and using the monthly returns, you arrive at a beta of 2.5. The market risk
premium for the market where this share is traded is 7.2 percent. The yield for the
government security which is typically considered to be risk free is 6 percent. What
do you think about this stock's current price in the market?

Expected Dividend D1 11
Growth (g) 6%
Cuurent Market Price 50
Beta (b) 2.5
Market Premium (Mr) 7.20%
Expected return
(CAPM) (r ) 24.00% Rf+b(Mr)
Price of Share using
Expected return 61.111 D1/(r-g)

Price as per CAPM is 61.11 however, the current Market price is 50. Stock is undervalued
If your cousin who is market savvy approached you and requested an advice on
identifying the overvalued stock from a set of three stocks in the market that she
is tracking. Based on the current market price, the three stocks Alpha, Beta and
Gamma have a required return of 18 percent, 15 percent and 12 percent respectively.
You computed their expected returns based on CAPM and arrived at returns of 19
percent, 13 percent and 14 percent respectively. Which stock(s) is(are) overvalued
among the three stocks?

Stocks RR ER (CAPM) Status

Alpha 18% 19% Overvalued
Beta 15% 13% Undervalued
Gamma 12% 14% Overvalued
You are a manager in High-Tech hospital, a super-speciality hospital in Mumbai.
To further enhance the treatment outcomes in patients with chronic pain, you are
considering to invest in a new project that will revolutionize the way we treat pain.
You are planning to employ Virtual Reality (VR) and Spastic suits in patients for
pain management in your hospital. The technology and the prototype has been
patented by a start-up firm, NoPain Tech, based in India. You have an initial
investment requirement of |75 million for a set of suits for various functions and
|60 million investment in the VR equipment by NoPain. Both equipment and the
suits have a useful life of 4 years and the hospital is planning to employ a straight
line method of depreciation to |10 million book value for the suits and |0 million
book value for the VR equipment. You don't expect the equipment and the suit to
fetch any salvage value at the end of the project.
The number of patients that you are expecting in the next 4 years is as follows:
1000, 2500, 5000, and 10000. The revenue expected per patient is |15,000 and the
cost is |10,000 for labour and general administration. Since this a new treatment,
the insurance companies have not approved this treatment. Hence, all patients are
expected to settle in cash. You have managed to secure debt financing of |50 million
at a real interest rate of 15% per annum. The weighted average cost of capital
arrived by the management for this project is 18% in real terms, high compared
to industry benchmark, as the technology is new and untested. The in
ation rate is 4%. What are the operating cashflows of this project ? What is the NPV of
this project ? Should this hospital adopt this technology? (Hint, convert the real
discount rate to nominal discount rate by adding (approx) inflation)

Suit 75 65 10
VR 60 15 0
Life 4
Cost of capital Real 18%
Inflation 4%
Nominal Cost of capital 22% Real + Inflation
Assumed No Tax rate
The cashflow every year are nominal cashflow, hence are not adjusted inflation.

Period 0 1 2 3 4
Patient 1,000 2,500 5,000 10,000

Revenue per Patient 15,000 15,000 15,000 15,000

Cost per Patient 10,000 10,000 10,000 10,000
Profit per Patient 5,000 5,000 5,000 5,000
Total profit 5,000,000 12,500,000 25,000,000 50,000,000
Profit in Million/ Op Cashflows 5 12.5 25 50

NPV -86.17
Reject the project as NPV is negative
You are considering purchasing blast hole drills for a new site. You have been
approached by SBSH and Komatsu with quotes for their latest 250mm blast hole
drills. SBSH product has a purchase price of |10 crores and has a useful life of 10
years. Whereas, the Komatsu one has a initial purchase price of |15 crores and a
useful life of 15 years. However, the maintenance cost of the SBSH equipment is |50
lakhs per year and the Komatsu has a maintenance of |30 lakhs per year. Which
drill should you choose ? Assume the tax rate is 20% and discount rate for DMDC
Ltd is 15%. DMDC has decided to employ Straight line method of depreciation to
zero book value. SBSH drills doesn't have any salvage value, whereas the Komatsu
one has a salvage value in the second hand market of 2 crores. Which option should
you choose ?

SBSH
Cost of Asset 10
Life (in years) 10
Maintenance cost per y 0.5

Komatsu
Cost of Asset 15
Life (in years) 15
Maintenance cost per y 0.3
Salvage value 2
Tax Rate 20%
Discount rate 15%

Year 0 1 2 3 4

Depreciation schedule
Depreciation 1 1 1 1
EOY BV 10 9 8 7 6

SBSH
Period 0 1 2 3 4
Maintenance cost -0.5 -0.5 -0.5 -0.5
After tax cost -0.4 -0.4 -0.4 -0.4
Dep 1 1 1 1
Dep tax sheild 0.2 0.2 0.2 0.2
After tax cashflow -0.2 -0.2 -0.2 -0.2
Machinery cost 10
Npv -11.00
PVAC ₹ -2.19

Komatsu

Year 0 1 2 3 4

Depreciation schedule
Depreciation 1 1 1 1
EOY BV 15 14 13 12 11
Period 0 1 2 3 4
Maintenance cost -0.3 -0.3 -0.3 -0.3
After tax cost -0.24 -0.24 -0.24 -0.24
Dep 1 1 1 1
Dep tax sheild 0.2 0.2 0.2 0.2
After tax cashflow -0.04 -0.04 -0.04 -0.04
Salvage value
SVT
Machinery cost 15
Cash flow 15 -0.04 -0.04 -0.04 -0.04
Npv -15.04
PVAC ₹ -2.57

We will choose SBSH

 5 6 7 8 9 10

1 1 1 1 1 1
5 4 3 2 1 0

5 6 7 8 9 10
-0.5 -0.5 -0.5 -0.5 -0.5 -0.5
-0.4 -0.4 -0.4 -0.4 -0.4 -0.4
1 1 1 1 1 1
0.2 0.2 0.2 0.2 0.2 0.2
-0.2 -0.2 -0.2 -0.2 -0.2 -0.2

5 6 7 8 9 10 11 12 13 14

1 1 1 1 1 1 1 1 1 1
10 9 8 7 6 5 4 3 2 1
 5 6 7 8 9 10 11 12 13 14
-0.3 -0.3 -0.3 -0.3 -0.3 -0.3 -0.3 -0.3 -0.3 -0.3
-0.24 -0.24 -0.24 -0.24 -0.24 -0.24 -0.24 -0.24 -0.24 -0.24
1 1 1 1 1 1 1 1 1 1
0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2
-0.04 -0.04 -0.04 -0.04 -0.04 -0.04 -0.04 -0.04 -0.04 -0.04

-0.04 -0.04 -0.04 -0.04 -0.04 -0.04 -0.04 -0.04 -0.04 -0.04
15

1
0
 15
-0.3
-0.24
1
0.2
-0.04
2
-0.4

1.56