STATISTIC AND QUANTATIVE METHODS

MD. Hasan Sharif (L0976SYSY0211)

This is an assignment for SQM BABMS 1, 2011 intake. Course lecturer is David Acquaye. This assignment contains Investment Appraisal, Correlation, Standard Deviation and Regression Analysis Method.

London School of Commerce White Hart Yard, Chaucer House, London. SE1 1NX +447703541954 4/18/2011

Question 1
A companyis consideringinvesting in a project. Ithas four options tochoose from. The followinginformation isavailable for youranalysis: Project A - Poultry Year NetCashflows (000) 1 250 2 320 3 380 4 450 5 480 Project B - RealEstate Year NetCashflows (000) 1 650 2 650 3 420 4 680 5 700 Project C - Retail Year 1 2 3 4 5 Project D - Hotel Year 1 2 3 4 5

NetCashflows (000) 290 345 550 580 600

NetCashflows (000) 165 180 250 290 350

The cost of capital forall projectsis10%

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The initial investments of the projectsareasfollow Project A =1,300,000 Project B =2,300,000 Project C = 1,800,000 Project D=850,000 YouarerequiredtousePayback, NetPresentValue, The IRR, The Profitability Index analysistoprepare a reportfor the companyrecommending the company on the best project.

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Answer to the question no. 1

Using Methods of Investment Appraisal report prepared to get a proper analysis of all the four projects. This report will help the company to decide which project will give the best output of its investment.

Project A
Project A is based on Poultry industry with initial investment of 1300000. Calculation of Payback Period (PB) is done below Year Net Cash Inflow 000 Cumulative Cash Flow 000 0 (1300) 1 250 250 2 320 570 3 380 950 4 450 1400 5 480 1880

From above calculation we can get that the project will get its initial investment back in the 4th year. To get to know exact month of investment return, calculation done below Remaining balance in 4th year is (1300000 950000) = 350000 So, Payback Period is = = 0.778 = 9.336 months Therefore, Total Payback Period is 3 years and 9 months.

Cost of Capital (COC) for the project is 10%. Calculating Net Present Value (NPV) for the Poultry project Year Net Cash Inflow 000 Discount Rate @ 10% 1 2 3 4 5 250 320 380 450 480 0.909 0.826 0.751 0.683 0.621 Discounted Cash Flow 000 227.25 264.32 285.38 307.35 298.08 1382.38 (1300.00) Page | 3

Initial investment

Therefore NPV =

82.38

Calculation of Internal Rate of Return (IRR) for Poultry Project using 19% Discount Rate Year Net Cash Inflow Discount Rate @ 19% Discounted Cash Flow 1 250 0.840 210 2 320 0.706 225.92 3 380 0.593 225.34 4 450 0.499 224.55 5 480 0.419 201.12 1086.93 Initial Investment (1300.00) Therefore NPV = (213.07)

Calculation of IRR done through formula IRR = IRR = IRR = IRR = 10 + 0.2788 9 IRR = 10 + 2.5092 IRR = 12.51%

Profitability Index (PI) calculated using above information Initial Investment is 1300000 Sum of Discounted Cash flow is 1382380 We know, PI = PI = PI = 1.0634
  

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Project B
Project B is based on Real Estate industry with initial investment of 2300000. Calculation of PB is done below Year Net Cash Inflow 000 Cumulative Cash Flow 000 0 (2300) 1 650 650 2 650 1300 3 420 1720 4 680 2400 5 700 3100

From above calculation we can get that the project will get its initial investment back in the 4th year. To get to know exact month of investment return, calculation done below Remaining balance in 4th year is (2300000 1720000) = 580000 So, Payback Period is = = 0.8529 = 10.235 months Therefore, Total PB is 3 years and 10 months. COC for the project is 10%. Calculating NPV for the Real Estate project Year Net Cash Inflow 000 Discount Rate @ 10% Discounted Cash Flow 000 1 650 0.909 590.85 2 650 0.826 536.9 3 420 0.751 315.42 4 680 0.683 464.44 5 700 0.621 434.7 2342.31 Initial investment (2300.00) Therefore NPV = 42.31

Calculation of IRR for Real Estate Project using 19% Discount Rate Year Net Cash Inflow Discount Rate @ 19% Discounted Cash Flow 1 650 0.840 546 2 650 0.706 458.9 3 420 0.593 249.06 4 680 0.499 339.32 5 700 0.419 293.3 Page | 5

Initial Investment Therefore NPV =

1886.58 (2300.00) (413.42)

Calculation of IRR done through formula IRR = IRR = IRR = IRR = 10 + 0.0928 9 IRR = 10 + 0.8352 IRR = 10.84%

PI calculated using above information Initial Investment is 2300000 Sum of Discounted Cash flow is 2342310 We know, PI = PI = PI = 1.0184
  

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Project C
Project C is based on Retail industry with initial investment of 1800000. Calculation of PB is done below Year Net Cash Inflow 000 Cumulative Cash Flow 000 0 (1800) 1 290 290 2 345 635 3 550 1185 4 580 1765 5 600 2365

From above calculation we can get that the project will get its initial investment back in the 5th year. To get to know exact month of investment return, calculation done below Remaining balance in 4th year is (1800000 1765000) = 35000 So, Payback Period is = = 0.0583 = 0.7 month Therefore, Total PB is 4 years and 0.7 month. COC for the project is 10%. Calculating NPV for the Retail project Year Net Cash Inflow 000 Discount Rate @ 10% Discounted Cash Flow 000 1 290 0.909 263.61 2 345 0.826 284.97 3 550 0.751 413.05 4 580 0.683 396.14 5 600 0.621 372.6 1730.37 Initial investment (1800.00) Therefore NPV = (69.63)

PI calculated using above information Initial Investment is 850000 Sum of Discounted Cash flow is 901840 We know, Page | 7

PI = PI =

PI = 0.9613

Project D
Project D is based on Hotel industry with initial investment of 850000. Calculation of PB is done below Year Net Cash Inflow 000 Cumulative Cash Flow 000 0 (850) 1 165 165 2 180 345 3 250 595 4 290 885 5 350 1235

From above calculation we can get that the project will get its initial investment back in the 4th year. To get to know exact month of investment return, calculation done below Remaining balance in 4th year is (850000 595000) = 255000 So, Payback Period is = = 0.5204 = 6.2448 months Therefore, Total PB is 3 years and 6 months. COC for the project is 10%. Calculating NPV for the Hotel project Year Net Cash Inflow 000 Discount Rate @ 10% Discounted Cash Flow 000 1 165 0.909 149.99 2 180 0.826 148.68 3 250 0.751 187.75 4 290 0.683 198.07 5 350 0.621 217.35 901.84 Initial investment (850.00) Therefore NPV = 51.84

Calculation of IRR for Hotel Project using 19% Discount Rate Year Net Cash Inflow Discount Rate @ 19% Discounted Cash Flow Page | 8

1 2 3 4 5

165 180 250 290 350

0.840 0.706 0.593 0.499 0.419

Initial Investment Therefore NPV =

138.6 127.08 148.25 144.71 146.65 705.29 (850.00) (144.71)

Calculation of IRR done through formula IRR = IRR = IRR = IRR = 10 + 0.2637 9 IRR = 10 + 2.3733 IRR = 12.37%

PI calculated using above information Initial Investment is 850000 Sum of Discounted Cash flow is 901840 We know, PI = PI = PI = 1.061
  

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Using Payback Period, Net Present Value, Internal Rate of Return and Profitability Index we have retracted all the numbers of Investment Appraisal, of four projects been provided to us with information; in the sense to decide on which project the company should invest for receiving the highest output for its investment. Chart below shows all the information been retracted for comparison Projects Poultry Real Estate Retail Hotel Payback Period in Years 3.9 3.10 4.07 3.6 Net Present Value (NPV) 82380 42310 (69630) 51840 Internal Rate of Return (IRR) % 12.51 10.84 12.37 Profitability Index (PI) 1.0634 1.0184 0.9613 1.061

We can see from the chart, Retail has got the highest Payback Period and the lowest Profitability Index. As the Cost of Capital is 10%, it has already got a negative NPV. All these numbers make it a very low profile project, probably indicating a loss project. We definitely do no recommend a project with negative NPV as it lowers shareholders wealth. On the other hand, Poultry, Real Estate and Hotel industry has got a positive NPV, which would increase shareholders wealth. We can see, Hotel industry has got the lowest Payback Period, ahead from Real Estate industry with high NPV, IRR and PI. It is competing with Poultry in IRR and PI with a very little distance. Poultry has the lead with higher NPV, IRR and PI. The only drawback is little high Payback period. Below we have ranked these industry prioritising which one is the best to invest Poultry is highly recommended Hotel is compatible Real Estate can be a food for thought

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Question 2
A housingconsultant believesthatthenumber of housessoldina regionfora given year isrelated to themortgage ratein that period. He collectsthe following relevantdata Year 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 (1) Mortgage InterestRate (X) 12 10 8 6 7 8 10 12 14 13 11 HousingSales Index (Y) 80 90 105 115 125 120 115 100 85 70 80

Calculate thecorrelation coefficientusing (a) Productmoment correlationcoefficient (Pearson) (b) Rank correlationcoefficient (Spearman)

(2)

Discusstheresultsobtained above.

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Answer to the question no. 2

1a. Product moment correlation (Pearson)

Year Mortgage Interest Rate Housing Sale Index 1982 12 80 1983 10 90 1984 8 105 1985 6 115 1986 7 125 1987 8 120 1988 10 115 1989 12 100 1990 14 85 1991 13 70 1992 11 80 111 1085

xy 144 6400 960 100 8100 900 64 11025 840 36 13225 690 49 15625 875 64 14400 960 100 13225 1150 144 10000 1200 196 7225 1190 169 4900 910 121 6400 880 1187 110525 10555

Calculation done through formula

r= r= r= r= r= r= r = -0.8129

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1b. Rank Correlation Coefficient (Spearman)

Year Mortgage Interest Rate Housing Sales Index Rm Rh d = Rm - Rh 1982 8.5 2.5 6 36 12 80 1983 5.5 5 0.5 .25 10 90 1984 3.5 7 -3.5 12.25 8 105 1985 1 8.5 -7.5 56.25 6 115 1986 2 11 -9 81 7 125 1987 3.5 10 -6.5 42.25 8 120 1988 5.5 8.5 -3 9 10 115 1989 8.5 6 2.5 6.25 12 100 1990 11 4 7 49 14 85 1991 10 1 9 81 13 70 1992 7 2.5 4.5 20.25 11 80 111 1085 393.25

Calculation done through formula

r=1-

r=1r=1 r=1 r=1r=1 r=1

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r = 1 1.834 r = 0.834

Question 3
The data below shows the weekly take-home-pay of workersinBirmingham.
Weekly take-home-pay (00) Number of Workers

30 31 3132 32 33 33 34 34 35 35 36 36 37 37 38 38 39 a. Youare required to i. ii.

3 7 33 26 24 20 18 15 4

Drawa cumulative frequencycurve for the above information Use yourCumulative frequencycurve toestimate theupper and lower quartiles. [Youare requiredtouse yourcomputertodraw]

b.

Calculate the distribution.

standard

deviationof

the

c.

Discussthe importance deviationinbusiness.

or

uses

standard

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Answer to the question no. 3

a1. Calculating Cumulative Frequency

Wages 00 No. of workers (f) Cumulative Frequency (cf) 30 31 3 3 31 32 7 10 32 33 33 43 33 34 26 69 34 35 24 93 35 36 20 113 36 37 18 131 37 38 15 146 38 - 39 4 150

Cumulative Frequency curve

160 140 120 100 80
60 40 20 0 Series 1

Column1 Column2

30 - 31 31 - 32 32 - 33 33 - 34 34 - 35 35 - 36 36 - 37 37 - 38 38 - 39

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a2. Estimating Upper and Lower Quartile Upper Quartile = = = =112.5 Lower Quartile = = = = 37.5

b. Calculating Standard Deviation

Wages 00 No. of Workers Mid Value (x) 30 31 3 30.5 31 32 7 31.5 32 33 33 32.5 33 34 26 33.5 34 35 24 34.5 35 36 20 35.5 36 37 18 36.5 37 38 15 37.5 38 - 39 4 38.5 = 150

fx 91.5 220.5 1072.5 871 828 710 657 562.5 154 fx = 5167

2790.75 6945.75 34856.25 29178.52 28566 25205 23980.5 21093.75 5929 =178545.5

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Calculation done through Formula

    

Importance of Standard Deviation Standard deviation is used for the measurement of variability and diversity in Probability Theory and Statistics. Below the importance of Standard Deviation is been listed It let us know the variation from average. In a set of data; helps us to understand the variability. Over time it measures variability of Investment Return. Measure of uncertainty in statistics. Helps to get a hold on Statisti cal Process Control (SPC). Helps to measure risk of investment, e.g. higher variation higher risk Calculating Standard Deviation while interpreting data gives a clear picture of the quality of data collected, means, how good they are .

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Answer to the question no. 4

SUMMARY OUTPUT Regression Statistics Multiple R 0.76864 R Square 0.590808 Adjusted R 0.473896 Square Standard 3.318601 Error Observatio 10 ns ANOVA df Regression Residual Total 2 7 9 Coefficien ts Intercept X Variable 1 X Variable 2 16.42398 0.930672 SS 111.308 2 77.0917 9 188.4 Standar d Error 4.35101 5 0.29494 3 0.11888 9 MS 55.654 11 11.013 11 F 5.0534 4 Significan ce F 0.043827

-0.07387

t Stat 3.7747 48 3.1554 3 0.6213 2

P-value 0.0069 4 0.0160 3 0.5540 74

Lower 95% 6.135469 0.233243

Upper 95% 26.712 5 1.6281 02 0.2072 59

-0.35499

Lower 95.0% 6.1354 69 0.2332 43 0.3549 9

Upper 95.0% 26.712 5 1.6281 02 0.2072 59

RESIDUAL OUTPUT Observatio n 1 2 3 4 5 6 Predicted Y 16.58636 19.57037 21.65332 24.076 18.37384 19.31915 Residual s 0.41363 8 3.42962 9 -1.65332 -6.076 0.62616 1 2.68084 Page | 18

7 8 9 10

20.27944 26.49867 24.19412 15.44873

6 0.72056 1 1.50132 7 1.80588 1 -3.44873

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