Homework Answers
2. We find the IRR using goal seek function in excel
Lets Assume DF to be 20%, we find the NPV as below:
| Interest | 20.00% | ||
| Year | Amount | DF | PV |
| 0 | -5,00,000.00 | 1.00 | -5,00,000 |
| 1 | 1,50,000.00 | 0.83 | 1,25,000 |
| 2 | 2,50,000.00 | 0.69 | 1,73,611 |
| 3 | 3,10,000.00 | 0.58 | 1,79,398 |
| NPV | -21,991 |
Now we use goal seek function, such that NPV is Nil and with changing Interest Rate we get,
| Interest | 17.48% | ||
| Year | Amount | DF | PV |
| 0 | -5,00,000.00 | 1.00 | -5,00,000 |
| 1 | 1,50,000.00 | 0.85 | 1,27,680 |
| 2 | 2,50,000.00 | 0.72 | 1,81,135 |
| 3 | 3,10,000.00 | 0.62 | 1,91,185 |
| NPV | 0 |
At DF of 17.48%, NPV is Nil. Hence 17.48% is the IRR.
Since our cost of capital of 12% is below IRR 17.48%, project is acceptable.
3. Profitability Index
The Profitability Index (PI) measures the ratio between the present value of future cash flows and the initial investment.
If the PI is greater than 1, the project generates value and the company may want to proceed with the project.
We find the present value of cash inflow:
| Interest | 9.00% | ||
| Year | Amount | DF | PV |
| 1 | 70,000.00 | 0.92 | 64,220 |
| 2 | 2,30,000.00 | 0.84 | 1,93,586 |
| 3 | 3,35,000.00 | 0.77 | 2,58,681 |
| Total PV | 5,16,488 |
Profitability Index = PV of Cash Inflows / Initial Investment = 516,488 / 365000 = 1.42
As PI is above 1, project is acceptable.
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