PROJECT APPRAISAL
What is the Investing?
Investing is where you use money to make more money.
There are so many methods that we can use to improve our money such as ,
1. Invest in the bank
2. Invest in the stock exchange market
3. Invest in a business etc
There is a risk when we invest. Risk should be minimized.
Example: some banks pay low interest, but they are having low risk.
Some banks give high interest, but they are high risk also.
How can you tell whether an investment is risky? Or which investment is more risky than others?
There are many ways to compare investments, but two of the most popular ways are:
1. Net Present Value
2. Internal Rate of Return
First let us learn what Present Value is?
Present Value (PV)
Money now is more valuable than money later on.
Why? Because you can use money to make more money!
You could run a business, or buy something now and sell it later for more, or invest the money in the bank to
earn interest.
Example
(1.) You can get 10% interest per annum on your money.
So Rs. 1,000 now can earn Rs.1,000 x 10% = Rs. 100 in a year.
Your Rs 1,000 now can become Rs.1,100 in a year's time.
1
Present Value Formula
Examples
(1) Arjuna promised you to pay Rs.2,000 in 4 years time. What is the Present Value (using at 10% rate of
discount)?
The Future Value (FV) is Rs.2,000,
The interest rate (r) is 10%, which is 0.10 as a decimal, and
The number of years (n) is 4.
So the Present Value of Rs.2, 000 in 4 years is:
PV = FV / (1+r)n
PV = Rs.2, 000 / (1 + 0.10)4
PV = Rs.2, 000 / 1.104
PV = Rs.1,366.03
It is saying that value is Rs. 1,366.03 now for Rs.2,000 in 4 years (at 10%).
(2) If you will get Rs.3,000 in 3 years , what is the present Value (discounting rate is 10%)
The Future Value (FV) is Rs.3,000,
The interest rate (r) is 10%, which is 0.10 as a decimal, and
The number of years (n) is 3.
So the Present Value of Rs.3,000 in 3 years is:
PV = FV / (1+r)n
PV = Rs.3,000 / (1 + 0.10)3
PV = Rs.3,000 / 1.103
PV = Rs.2,253.95
It is saying that value is Rs. 2,253.95 now for Rs.3,000 in 3 years (at 10%).
(3) What is value now if you get Rs. 6,500 in next year at the rate of 10%?
PV = Rs. 6,500 / (1+0.10)1 = Rs. 6,500 / 1.10 = Rs. 5,909.09 (to nearest cent)
2
(4) What is the value now if you get Rs. 6,500 in next year the rate of 15%?
PV = Rs.6,500 / (1+0.15)1 = Rs. 6,500/ 1.15 = Rs.5,652.17 (to nearest cent)
Net Present Value
The NPV of a project or investment reflects the degree to which cash inflow, or revenue, equals or exceeds
the amount of investment capital required to fund it.
STEPS TO CALCULATION NPV
1. Determine your initial investment
2. Determine a time period to analyze.
3. Estimate your cash flows for each time period
4. Determine the appropriate discount rate.
5. Discount your cash flows.
Examples
(1) Amal needs Rs. 1,000 now, and will pay you back Rs. 1,350 in a year. Is that a good investment when
you can get at 10% per year?
Cash OutFlow: Rs. 1,000 now
You invested Rs 1,000 now, so PV = - Rs 1,000
Cash InFow: Rs 1,350 next year
PV = Rs 1,350 / (1+0.10)1 = Rs 1.350 / 1.10 = Rs 1,227.28 (to nearest cent)
The Net Amount is:
Net Present Value = Rs 1,227.28 – 1,000 = Rs 227.28
If the Net Present Value (NPV) is positive it is good (and negative is bad).
(2) Invest Rs.20,000 now and receive 3 yearly payments of Rs.5,000 each, plus Rs.12,000 in the 3rd year.
Use 10% discount Rate. Find NPV.
Initial investment = Rs. 20,000
Period = 3years
Discount rate = 10%
3
Method 1
Year Cash Flow DCF @ 10% Present Value
0 (20,000.00) 1.00 (20,000.00)
1 5,000.00 0.9091 4,545.45
2 5,000.00 0.8264 4,132.23
3 5,000.00 0.7513 3,756.57
3 12,000.00 0.7513 9,015.78
NPV 1,450.04
Method 2
Now: PV = - Rs 20,000
Year 1: PV = Rs 5,000 / 1.10 = Rs 4,545.45
Year 2: PV = Rs 5,000 / 1.102 = Rs 4,132.23
Year 3: PV = Rs 5,000 / 1.103 = Rs 3,756.57
Year 3 (final payment): PV = Rs 12,000 / 1.103 = Rs 9,015.78
Adding those and get:
NPV = - Rs 20,000 + Rs 4,545.45+ Rs 4,132.23+ Rs 3,756.57+ Rs 9,015.78 = Rs 1,450.04
This investment should be accepted.
(3) A project with a 3 year life and a cost of Rs. 100,000 generates revenue of Rs. 25,000 in year 1, Rs.
45,000 in year 2, and Rs. 65, 000 in year 3. If the discount rate is 8%, what is the NPV of the project?
Method 1
Year Cash Flow DCF @ 8% Present Value
0 (100,000.00) 1.00 (100,000.00)
1 25,000.00 0.9259 23,148.15
2 45,000.00 0.8573 38,580.25
3 65,000.00 0.7938 51,599.10
NPV 13,327.49
NPV is positive then project should be accepted.
4
Method 2
Now: PV = - Rs 100,000
Year 1: PV = Rs 25,000 / 1.08 = Rs 23,148.15
Year 2: PV = Rs 45,000 / 1.082 = Rs 38,580.25
Year 3: PV = Rs 65,000 / 1.083 = Rs 51,599.10
Adding those up gets:
NPV = - Rs 100,000 + Rs 23,148.15+ Rs 38,580.25+ Rs 51,599.10= Rs 13,327.49
(4) A project with a 4 year life and a cost of Rs. 225,000 generates revenue of Rs. 48,000 in year 1, Rs.
67,000 in year 2, Rs. 95, 000 in year 3 and Rs. 110,000 in year 4. If the discount rate is 15%, Can be
accepted the project?
Year Cash Flow DCF @ 15% Present Value
0 (225,000.00) 1.00 (225,000.00)
1 48,000.00 0.8696 41,739.13
2 67,000.00 0.7561 50,661.63
3 95,000.00 0.6575 62,464.04
4 110,000.00 0.5718 62,892.86
NPV (7,242.34)
Project cannot be accepted due to negative NPV.
Method 2
Now: PV = - Rs 225,000
Year 1: PV = Rs 48,000 / 1.15 = Rs 41,739.13
Year 2: PV = Rs 67,000 / 1.152 = Rs 50,661.63
Year 3: PV = Rs 95,000 / 1.153 = Rs 62,464.04
Year 4: PV = Rs 110,000 / 1.154 = Rs 62,892.86
Adding those and get:
NPV = - Rs 225,000 + Rs 41,739.13+ Rs 50,661.63+ Rs 62,464.04+Rs. 62,892.86 = Rs (7,242.34)
