IMPORTANT THEORY Q&A

TOTAL PAGES 13. TOTAL QUE 24

Q#1
Retained earnings can be used to finance the capital expenditure. However, using retained
earning as a means of capital expenditure has its own advantages and disadvantages.
Mention them briefly.

ANS:
The portion of profits not distributed among the shareholders but retained and used in
business
is called retained earnings. It is also referred to as ploughing back of profit. This is one of the
important sources of internal financing used for fixed as well as working capital. Retained
earnings increase the value of shareholders in case of a growing firm.
Advantages of Retained Earnings:
The advantages or benefits of retained earnings may be stated as under:
i. Cheaper Source of Financing:
The use of retained earnings does not involve any acquisition cost. The company has no
obligation to pay anything in respect of retained earnings.
ii. Financial Stability:
Retained earnings strengthen the financial position of a business and thereby give financial
stability to the business.
iii. Stable Dividend:
Shareholders may get stable dividend even if the company does not earn enough profit.
iv. Market Value:
Retained earnings strengthen the financial position of a company and appreciate the capital
which ultimately increases the market value of shares.
Disadvantages of Retained Earnings:
Retained earnings are the result of conservative dividend policy of the company and are
associated with following demerits:
i. Improper Utilization of Funds:
If the purpose for utilization of retained earnings is not clearly stated, it may lead to careless
spending of funds.
ii. Over-capitalization:
Conservative dividend policy leads to huge accumulation of retained earnings leading to over-
capitalization.
iii. Lower Rate of Dividend:
Retained earnings do not allow shareholders to enjoy full benefit of the actual earnings of the
company. This creates not only dissatisfaction among the shareholders but also adversely
affect the market value of shares.

Q#2
While taking an investment decision why do you think that using EPS to assess the
performance of the company is not worthwhile?
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Answer:
(EPS) is often touted as one of the most important ways of measuring a stock’s worth. While it
certainly has its uses it is also open to manipulation and shouldn’t be used in isolation.
Investors looking to buy stock should make far more use of free cash flow when assessing the
quality of a company’s earnings.

1. Management knows investors rely on using EPS as a guidance for company

performance so they’ll naturally want the EPS figure to appear as high as possible in the
short term. They may make decisions to maximise the EPS figure in the short term,
which may damage the entity’s prospects in the long term.
2. EPS also doesn’t consider cash flow. Management may focus so much on increasing
the earnings figure, they start selling to bad customers who don’t pay or sell at lower
margins. If the company can’t earn cash to pay its bills, no matter how large the earnings
are, it may be insolvent.
3. EPS also ignores inflation, the price of goods and services generally may be increasing,
so this could be contributing to the good EPS figure, but this growth might be misleading
if the company can’t buy as many goods this year as it could last year.
4. Also, each company has different accounting policies; this makes it harder to compare
individual companies on a like for like basis.

Q#3
Short-term financing is generally riskier than long-term financing. Nonetheless, it has
some significant advantages, which cannot be overlooked. You are requested to
elucidate the advantages of short term financing. (5 marks)
Answer

Easy to Obtain: Creditors make short-term funds easier to obtain as the risk involved in
delivering loan varies according to payment time, and they think long-term credits or loans
contains high-risk factor than short-term loans.

Less Risky: In Comparison with long-term financing, short-term financing is less risky, as
creditors grant credit for a short period of time.
Resilience: Short-term financing provides resilience as the borrower may adopt alternative
sources of credit after negotiating the short-term credit account by debtors.
Take Care of Emergencies :
Even the best planner can't plan for emergencies. These pop up out of nowhere and can be
devastating on the business front. So, the best way to prepare for emergency situations is to
have insurance. Short term loans are exceptional forms of insurance since they are quick to
obtain.

Improve Your Credit Rating :

Now, the great thing about short term loans is that they give your credit score a boost. This
can be helpful in getting longer-term loans and bigger lines of credit in the future. Small
businesses oftentimes struggle with obtaining these because of lack of good credit.

Q#4
A Company planning to grow by pursuing a policy of ‘organic’ internal growth, would
need to take into account certain factors. Explain these factors in brief. (5 marks)
Answer
Organic (or internal) growth involves expansion from within a business, for example by
expanding the product range, or number of business units and location. 2
Organic growth builds on the business’ own capabilities and resources. For most businesses,
this is the only expansion method used.
Organic growth involves strategies such as:
- Developing new product ranges
- Launching existing products directly into new international markets (e.g. exporting)
- Opening new business locations – either in the domestic market or overseas
- Investing in additional production capacity or new technology to allow increased output and
sales volumes

Q#5
Stakeholders legitimately interested in the activities of an organization falls into
three broad categories.
Enumerate them giving few examples of each one. (3 marks)

Answer:
Stakeholders three broad categories are as follows
1. Internal Stakeholder (Managers, Employees, Directors)
2. Connected Stakeholder (Shareholders, Lenders, Customer, Supplier, Competitors)
3. External Stakeholders (Govt. , Pressure Groups, Local Communities)

Q#6
Capital rationing maybe necessary in a business due to external factors i-e
hard capital rationing. What causes hard capital rationing? (3 marks)

1.Start-up Firms:
Generally, young start-up firms are not able to raise the funds from equity markets. This may
happen despite the high projected returns or the lucrative future of the company.
2.Poor Management / Track Record:
The external funds can also be affected by the bad track record of the company or the poor
management team. The lenders can consider such companies as a risky asset and may shy
away from investing in projects of these companies.
3.Lender’s Restrictions:
Quite often, medium sized and large sized companies rely on institutional investors and banks
for most of their debt requirements.There may be restrictions and debt covenants placed by
these lenders which affect the company’s fund-raising strategy.
4.Industry Specific Factors:
There could be a general downfall in the entire industry affecting the fund raising abilities of a
company

Q#7
Financial risk is a risk that a company would not be able to meet its obligation to
pay back its debts. How do the following stakeholders view this type of risk?
- The company as a whole
- Lenders
- Ordinary Shareholders
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 Answer­­
The Company As Whole: The Financial risk for the company as a whole is to long term
financial burden of interest that must be paid by the company. In case of default
company may be forced into liquidation by loan provider.
Lenders: Lenders financial risk that organization may be unable to pay interest and
principle amount when it becomes due.
Ordinary Shareholders: Shareholders are only eligible for dividend when there is excess
cash after paying interest, so in case of excess borrowing the shareholders income
become volatile and share prices fluctuate.

Q#8
According to the theory presented by Modigliani and Miller (MM), the financial
structure has no impact on the cost of capital and therefore the debt to equity
ratio has no impact on the value of the project. While presenting their theory, they
made certain assumptions. Briefly explain these assumptions. (4 marks)

Modigliani and Miller advocate capital structure irrelevancy theory, which suggests that the
valuation of a firm is irrelevant to the capital structure of a company. Whether a firm is highly
leveraged or has a lower debt component in the financing mix has no bearing on the value of a
firm.
Assumptions of Modigliani and Miller Approach
1. There are no taxes.
2. Transaction cost for buying and selling securities, as well as the bankruptcy cost, is nil.
3. There is a symmetry of information. This means that an investor will have access to the same
information that a corporation would and investors will thus behave rationally.
4. The cost of borrowing is the same for investors and companies.
5. There is no floatation cost, such as an underwriting commission, payment to merchant
bankers, advertisement expenses, etc.
6. There is no corporate dividend tax.

Q#9
The foremost purpose of a merger or a takeover is to create value. There are
number of reasons due to which mergers will result in value creation. Elucidate five
motives behind mergers and takeovers. (5 marks)

Companies pursue mergers and acquisitions for several reasons. The most common motives
for mergers include the following:
1. Value creation
Two companies may undertake a merger to increase the wealth of their shareholders. Generally,
the consolidation of two businesses results in synergies that increase the value of a newly
created business entity. Essentially, synergy means that the value of a merged company
exceeds the sum of the values of two individual companies. Note that there are two types of
synergies:

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 Revenue synergies: Synergies that primarily improve the company’s revenue-generating
ability.
For example, market expansion, production diversification, and R&D activities are
only a few factors that can create revenue synergies.

Cost synergies: Synergies that reduce the company’s cost structure. Generally, a successful
merger may result in economies of scale, access to new technologies, and even elimination of
certain costs. All these events may improve the cost structure of a company.

Acquisition of assets
A merger can be motivated by a desire to acquire certain assets that cannot be obtained using
other methods. In M&A transactions, it is quite common that some companies arrange mergers
to gain access to assets that are unique or to assets that usually take a long time to develop
internally. For example, access to new technologies is a frequent objective in many mergers.
Increase in financial capacity
Every company faces a maximum financial capacity to finance its operations through either debt
or equity markets. Lacking adequate financial capacity, a company may merge with another. As
a result, a consolidated entity will secure a higher financial capacity that can be employed in
further business development processes.
Tax purposes
If a company generates significant taxable income, it can merge with a company with
substantial carry forward tax losses. After the merger, the total tax liability of the consolidated
company will be much lower than the tax liability of the independent company.
Incentives for managers
Sometimes, mergers are primarily motivated by the personal interests and goals of the top
management of a company. For example, a company created as a result of a merger
guarantees more power and prestige that can be viewed favorably by managers. Such a motive
can also be reinforced by the managers’ ego, as well as his or her intention to build the biggest
company in the industry in terms of size. Such a phenomenon can be referred to as “empire
building,” which happens when the managers of a company start favoring the size of a company
more than its actual performance.
Additionally, managers may prefer mergers because empirical evidence suggests that the size
of a company and the compensation of managers are correlated.

Q#10
Describe three main reasons for soft & hard capital rationing? (3)

Hard capital rationing may arise for one of the following reasons.
(a) Raising money through the stock market may not be possible if share prices are depressed.
(b) There may be restrictions on bank lending due to government control.
(c) Lending institutions may consider an organization to be too risky to be granted further loan
facilities.
(d) The costs associated with making small issues of capital may be too great

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 Reasons for Soft Capital Rationing
A. Limited management skills in new area
B. Want to limit exposure and focus on profitability of small number of projects
C. The costs of raising the finance relatively high
D. No wish to lose control or reduce EPS by issuing shares
E. Wish to maintains high interest cover ratio
F. Internal Capital market” - deliberately restricting funds so competing projects become
more efficient
Q#11
Sensitivity analysis has its own weaknesses. Mention them in short. (5)
Weaknesses of sensitivity analysis
• It assumes that changes to variables can be made independently, e.g. material prices will
change independently of other variables. Simulation allows us to change more than one
variable at a time.
• It only identifies how far a variable needs to change; it does not look at the probability of
such a change.
• It provides information on the basis of which decisions can be made but it does not point to
the correct decision directly

Q#12
What is meant by Market efficiency? Briefly explain each form of market
efficiency. (4)
• Market efficiency refers to the degree to which market prices reflect all available, relevant
information. If markets are efficient, then all information is already incorporated into prices,
and so there is no way to "beat" the market because there are no undervalued or
overvalued securities available.
There are three forms of market efficiency which are as follows
1. Weak Form
2. Semi Strong form
3. Strong Form
Weak Form
In the weak-form efficient market hypothesis, all historical prices of securities have already
been reflected in the market prices of securities. In other words, technicians – those trading on
analysis of historical trading information – should earn no abnormal returns. Research has
shown that this is likely the case in developed markets, but less developed markets may still
offer the opportunity to profit from technical analysis.
Semi-strong Form

In a semi-strong-form efficient market, prices reflect all publicly known and available information,
including all historical price information. Under this assumption, analyzing any public financial
disclosures made by a company to determine a stock’s intrinsic value would be futile since
every detail would be taken into account in the stock’s market price. Similarly, an investor could
not earn consistent abnormal returns by acting on surprise announcements since the market
would quickly react to the new information.

Strong Form
In a strong-form efficient market, security prices fully reflect both public and private information.
Therefore, insiders could not generate abnormal returns by trading on private information
because it would already figure into market prices. Researchers find that markets are generally
not strong-form efficient as abnormal profits can be earned when nonpublic information is used.

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 Q#13
Explain each form of efficiency for fundamental analysis. (3)
Since abnormal returns from the analysis of historical prices would be quickly arbitraged away
in a weak-form efficient market, no technical analyst would be able to earn consistent
abnormal returns. However, fundamental analysis and insider trading can still earn abnormal
returns in a weak-form efficient market because public information and non-public
information would not necessarily be fully reflected in market prices. Similarly, active
management that utilizes fundamental analysis could also be capable of earning abnormal
returns. Therefore, active management could consistently outperform passive management
on a risk-adjusted basis – gross of fees – in a weak-form efficient market. If abnormal returns
earned by active fundamental analysis exceed additional active management fees, active
management could also earn abnormal returns net of fees.
Fundamental analysis and active management lose their abilities to earn abnormal returns in
a semi-strong efficient market due to prices fully reflecting public information. Despite active
management’s inability to outperform passive management at the same risk level, active
management may still be a rational investment option as a way for investors to manage
certain risks and achieve financial goals.
In strong-form efficient markets, even insider trading cannot earn abnormal profits. Most
markets are not strong-form efficient due to regulations against trading on non-public
information.
Q#14
Explain each form of efficiency for technical analysis. (3)

The weak form of the EMH claims that trading information (levels and changes of prices and
volumes) of traded assets are already incorporated in prices. If weak form efficiency holds
then technical analysis cannot be used to generate superior returns.
The semi-strong form of the EMH claims both that prices incorporate all publicly available
information (which also includes information present in financial statements, other SEC
filings etc.). If semi-strong form efficiency holds then neither technical analysis nor
fundamental analysis can be used to generate superior returns.
The strong form of the EMH additionally claims that prices incorporate all public and non-
public (insider) information, and therefore even insiders cannot expect to earn superior
returns (compared to the uninformed public) when they trade assets of which they have
inside information.

Q#15
What factors determine the optimal mix of financing I.e, the capital structure that
results is maximum value? Mention briefly any three of them (3)
The optimal capital structure is estimated by calculating the mix of debt and equity that
minimizes the weighted average cost of capital (WACC) of a company while maximizing its
market value.
The optimal structure involves using enough equity to mitigate the risk of being unable to pay
back the debt—taking into account the variability of the business’s cash flow.
Debt finance is cheaper than equity because of interest is tax deductible and prior charge
than equity holders in profit and liquidation.
Companies with consistent cash flows can tolerate a much larger debt load and will have a
much higher percentage of debt in their optimal capital structure. Conversely, a company with
volatile cash flows will have little debt and a large amount of equity. 7
Factors Determining Capital Structure
1-Trading on Equity-
The word “equity” denotes the ownership of the company. Trading on equity means taking
advantage of equity share capital to borrowed funds on reasonable basis. It refers to
additional profits that equity shareholders earn because of issuance of debentures and
preference shares. It is based on the thought that if the rate of dividend on preference capital
and the rate of
interest on borrowed capital is lower than the general rate of company’s earnings, equity
shareholders are at advantage which means a company should go for a judicious blend of
preference shares, equity shares as well as debentures. Trading on equity becomes more
important when expectations of shareholders are high.
2. Degree of control-
In a company, it is the directors who are so called elected representatives of equity
shareholders. These members have got maximum voting rights in a concern as compared to
the preference shareholders and debenture holders. Preference shareholders have
reasonably less voting rights while debenture holders have no voting rights. If the company’s
management policies are such that they want to retain their voting rights in their hands, the
capital structure consists of debenture holders and loans rather than equity shares
3. Flexibility of financial plan-
In an enterprise, the capital structure should be such that there is both contractions as well as
relaxation in plans. Debentures and loans can be refunded back as the time requires. While
equity capital cannot be refunded at any point which provides rigidity to plans. Therefore, in
order to make the capital structure possible, the company should go for issue of debentures
and other loans.
4-Choice of investors-
The company’s policy generally is to have different categories of investors for securities.
Therefore, a capital structure should give enough choice to all kind of investors to invest. Bold
and adventurous investors generally go for equity shares and loans and debentures are
generally raised keeping into mind conscious investors.
5-Capital market condition-
In the lifetime of the company, the market price of the shares has got an important influence.
During the depression period, the company’s capital structure generally consists of debentures
and loans. While in period of boons and inflation, the company’s capital should consist of
share capital generally equity shares.
5. Period of financing-
When company wants to raise finance for short period, it goes for loans from banks and other
institutions; while for long period it goes for issue of shares and debentures.
6. Cost of financing-
In a capital structure, the company has to look to the factor of cost when securities are raised.
It is seen that debentures at the time of profit earning of company prove to be a cheaper
source of finance as compared to equity shares where equity shareholders demand an extra
share in profits.

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1. Stability of sales-
An established business which has a growing market and high sales turnover, the company is in
position to meet fixed commitments. Interest on debentures has to be paid regardless of profit.
Therefore, when sales are high, thereby the profits are high and company is in better position to
meet such fixed commitments like interest on debentures and dividends on preference shares.
If company is having unstable sales, then the company is not in position to meet fixed
obligations. So, equity capital proves to be safe in such cases
8.Sizes of a company-
Small size business firms capital structure generally consists of loans from banks and retained
profits. While on the other hand, big companies having goodwill, stability and an established
profit can easily go for issuance of shares and debentures as well as loans and borrowings from

total capitalization.
financial institutions. The bigger the size, the wider is
Q#16
Systematic unsystematic risk

Systematic risk is risk associated with market returns. This is risk that can be attributed to broad
factors. It is risk to your investment portfolio that cannot be attributed to the specific risk of
individual investments.
Sources of systematic risk could be macroeconomic factors such as inflation, changes in
interest rates, fluctuations in currencies, recessions, wars, etc. Macro factors which influence
the direction and volatility of the entire market would be systematic risk. An individual company
cannot control systematic risk.
Unsystematic Risk
Unsystematic risk is company specific or industry specific risk. This is risk attributable or specific
to the individual investment or small group of investments. It is uncorrelated with stock market
returns.Examples of risk that might be specific to individual companies or industries are
business risk, financing risk, credit risk, product risk, legal risk, liquidity risk, political risk,
operational risk, etc. Unsystematic risks are considered governable by the company or industry
and can be nearly eliminated by diversification.

Q17: CAPM assumptions & Limitation? Assumptions:

1. All investors think in terms of a single period.

2. Investors act rational and choose their portfolio solely based on the expected return and its
standard deviation over that period, which means that returns have to be normally distributed
3. All investors can borrow or lend an unlimited amount of money at a given (and for all equal)
risk-free rate of interest.
4. All investors have homogeneous expectations, meaning that they identically estimate
expected returns, standard deviations and correlations of returns among all assets.
5. Homogeneous expectations require that all investors have constant and free access to all
required information regarding the investment decision. Furthermore, this information has to
be analyzed and evaluated equally by all. (Hug, 1993, pp. 131/132)
6. All assets are perfectly divisible and are perfectly marketable at the going price.
7. There are no transaction costs, taxes and restrictions on short sales of any asset.
8. The market is not constricted by any institution (Weber, 1990, p. 72).
9. Investors assume that their own acting will not affect prices (= price takers).
10. The quantities of all assets are given and fixed.
11. Investors are risk averse (Hug, 1993, p. 130). 9
 Limitations of CAPM

1-One of them is obviously the single period time horizon of the model. This means that
investors are only concerned with the wealth their portfolio produces at the end of the current
period. Investors in the real world have the intention of securing their lifetime consumption
level by the means of investing. Making optimal investment decisions by considering returns
over the next period only (single period model), is just achievable under further assumptions.
1. Another problem is that the model should only be based on forward-looking data, e.g.
the expected rate of return and the expected beta. Obviously, these cannot be estimated with
precision and are therefore often historically based
2. Other assumptions that do not comply with reality are the lack of free and instantly
available information (information market efficiency) and the exclusion of taxes and
transaction
costs .Furthermore, in reality a risk-free asset does not exist. Even government bonds, which
play this role in the practical usage of the CAPM actually contain risk as well.
3. It is also quite unrealistic that all investors have homogeneous expectations and that
they all act rationally, based on the expected return and the standard deviation

18.Difference between market and intrinsic value

There is a significant difference between intrinsic value and market value, though both are
ways of valuing a company.
Intrinsic value is an estimate of the actual true value of a company, regardless of market
value.
Market value is the current value of a company as reflected by the company’s stock price.
Therefore, market value may be significantly higher or lower than the intrinsic value.
Intrinsic value and market value, both terms estimate the company’s performance and value.
The intrinsic value measures a company’s real value without considering its market value.
The market value is nothing but the current price of the company’s stock. Investors use
intrinsic value to analyze the company’s performance. The rationale behind this is to invest in
a company which has greater value than value which is determined by the current market. If
the current market value of the company is lower than the company’s intrinsic value, that
means the company’s stocks are undervalued. If there is more demand for investment in the
company, then it increases the company’s market value. If the company’s current value is
higher than its intrinsic value, this means stocks of that particular company are overvalued.

Q.19- What is difference between pooling interest and purchasing method of

acquisition?
Amalgamation implies a process of unification of two or more companies, which are involved
in similar business to form a new company. As per Accounting Standard-14, Amalgamation
can take place in two ways, i.e. in the nature of merger and in the nature of the purchase.
When amalgamation is in the nature of merger the method of accounting used is the pooling
of interest method, whereas is the amalgamation is in the nature of the purchase, purchase
method of accounting is used.

In pooling of interest method, the assets and liabilities are recorded at their carrying
amounts in the books of the transferee company, whereas in purchase method, the assets
and liabilities of the acquired company are recorded in the books of acquiring company at
their fair market value, as on the date of acquisition.

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20-Understanding Forward Contracts

Unlike standard futures contracts, a forward contract can be customized to a commodity,

amount, and delivery date. Commodities traded can be grains, precious metals, natural gas,
oil, or even poultry. A forward contract settlement can occur on a cash or delivery basis.
Forward contracts do not trade on a centralized exchange and are therefore regarded as over-
the-counter (OTC) instruments. While their OTC nature makes it easier to customize terms, the
lack of a centralized clearinghouse also gives rise to a higher degree of default risk.

Because of their potential for default risk and lack of a centralized clearinghouse, forward
contracts are not as easily available to retail investors as futures contracts.

21-Forward Contracts vs. Futures Contracts

Both forward and futures contracts involve the agreement to buy or sell a commodity at a set
price in the future. But there are slight differences between the two. While a forward contract
does not trade on an exchange, a futures contract does. Settlement for the forward contract
takes place at the end of the contract, while the futures contract settles on a daily basis. Most
importantly, futures contracts exist as standardized contracts that are not customized
between counterparties.

22-Gordon's Theory on Dividend Policy

Gordon’s theory on dividend policy is one of the theories believing in the ‘relevance of
dividends’ concept. It is also called as ‘Bird-in-the-hand’ theory that states that the
current dividends are important in determining the value of the firm. Gordon’s model
is one of the most popular mathematical models to calculate the market value of the
company using its dividend policy.
Relation of Dividend Decision and Value of a Firm

The Gordon’s theory on dividend policy states that the

company’s dividend payout policy and the relationship between its rate of
return (r) and the cost of capital (k) influence the market
price per share of the company.

Relationship between r and k Increase in Dividend Payout

r>k Price per share decreases

r<k Price per share increases

r=k No change in the price per share

Assumptions of Gordon’s Model

No External Financing
Constant IRR
Constant Cost of Capital
Perpetual Earnings
Constant Retention Ratio 11
 Gordon’s formula to calculate the market price per
share (P) is

P = {EPS * (1-b)} / (k-g)

23-Methods of stock exchange listing

1. Offer for sale

2. Prospectus
3. issue Placing
4. Introduction

24-Investment Appraisal Techniques

Investment appraisal techniques are payback period, internal rate of return,

net present value, accounting rate of return, and profitability index. They
are primarily meant to appraise the performance of a new project. The first
question that comes to our mind before beginning any new project is
“Whether it is viable or profitable? These techniques answer this question
very well. Each technique evaluates the project from a different angle and
provides a different insight. Let us understand these techniques in brief.

Payback Period

One of the simplest investment appraisal techniques is the payback period.

Payback technique states how long does it take for the project to generate
sufficient cash-flow to cover the initial cost of the project.
The advantage of payback is, it is very easy to calculate & understand. Even people
not
from finance background can easily understand it. But the disadvantage is that it
ignores
the time value of money & anything that happens after a payback point.

Accounting Rate of Return Method

Accounting rate of return is an accounting technique to measure profit

expected from an investment. It expresses the net accounting profit arising
from the investment as a percentage of that capital investment. It is also
known as return on investment or return on capital
The formula of ARR is as follows:
ARR=(Average annual profit after tax / Initial investment) X 100

Net Present Value

It is the most common method of investment appraisal. Net present value is

the sum of discounted future cash inflow & outflow related to the project.
Generally, the weighted average cost of capital (WACC) is the discounting
factor for future cash-flows in net present value method.

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Internal Rate of Return Method
An internal rate of return is the discounting rate, which brings discounted future cash
flow at par with the initial investment. In other words, it is the discounting rate at which
the company will neither make loss nor make a profit.
It is obtained by trial & error method. We can also state that IRR is the rate at which the
NPV of the project will be zero. i.e. Present value of cash inflow – Present value of cash
outflow = zero
Profitability Index
Profitability index defines how much you will earn per dollar of investment. The
present value of an anticipated future cash flow divided by initial outflow gives the
profitability index (PI) of the project. It is also one of the easy investment appraisal
technique.
Discounted Payback Period Method

This method is the same as the payback period method. The only difference is, in
discounting payback method is that payback period is calculated on the basis of
discounted future cash-flows while in payback method it is calculated on the basis of
future cash-flows.

End

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