Session 10-27.02.19 Project Selection

UPES – The Nation Builders University
Session 10
27th February 2019
Centre for
Continuing Education
Project selection
Centre for
Project selection
models
Numeric Non-Numeric
Profitability Competitive
Scoring based Sacred cow
based necessity
Pay back Present unweighted Operative Product line

Factor Scoring
period value 0-1 Scoring necessity extension
Net present Internal Rate of Weighted factor

value return scoring Comparative
benefit model
Centre for
Numeric Models
• Present Value / Net Present Value
• Benefit / Cost Ratio
• Payback period
• Internal Rate of Return
• Scoring
Centre for
Present Value
The Present Value is the amount of money at time zero representing the
discounted cash flows for the project.
𝑭
𝑷𝑽 =
(𝟏 +𝒓)𝒏
PV
T=0 +/- Cash Flows
Centre for
If a project is expected to generate Rs 1000 at the end of 1 year and Rs
5000 at the end of 2 years, calculate the present value of both the
transactions if the rate of interest is 12%.
For first transaction

1000
𝑃𝑉 =
(1 + 0.12)1
= 1000 / 1.121
= Rs. 892.9
For second transaction

5000
𝑃𝑉 =
(1 + 0.12)2
5000
=
1.12 × 1.12
= Rs. 3985.96
Centre for
PRESENT VALUE TABLE
Centre for
The factor for year 1 and rate of interest 12% is 0.89286 in the table
So present value of Rs 1000, received after one year
= 0.89296 x 1000 = 892.96
The factor for year 2 and rate of interest 12% is 0.79719 in the table
So present value of Rs 5000, received after two years
= 0.79719 x 5000 = 3985.95
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Net Present Value (NPV)
The Net Present Value of an investment is the difference between cash

outflows and cash inflows on a present value basis.
NPV = ∑ Present Value (Cash inflow) - ∑ Present Value (Cash outflow)
Centre for
Initial Investment: Rs 100,000

Project Life: 10 years
Salvage Value: Rs 20,000
Annual Receipts: Rs 40,000
Annual Disbursements: Rs 22,000
Annual Discount Rate: 12%
What is the net present value for this project?

Is the project an acceptable investment?
Centre for
Present Value
Annual Receipts
Rs 40,000 Rs 226009
Salvage Value
Rs 20,000 Rs 6439
Annual Disbursements
Rs 22,000 Rs 124,305
Initial Investment (t=0) Rs 100,000
Net Present Value Rs 8143
Greater than zero, therefore acceptable project
Centre for
The expected investment and revenue from a project is given below. The life of project is estimated as 10 years.
Calculate the net present value of the project. Should the management take up this project? The rate of interest is 8%
Year Investment (Rs) Revenue (Rs)
(Initial investment) 50,000
1 20,000
3 10,000
4 35,000
5 5,000
6 25,000
8 40,000 5,000
10 12,000
Salvage value 2,000
Centre for
Present value Present value
Year Investment (Rs) Revenue (Rs) (Investment) (Revenue)
Factor from PV table
0 50,000 1.0 50,000

1 20,000 0.92593 18518.6
2
3 10,000 0.79383 7938.3
4 35,000 0.73503 25726.05
5 5,000 0.68058 3402.9
6 25,000 0.63017 15754.25
7
8 40,000 5,000 0.54027 21610.8 2701.35
9
10 12,000 0.46319 5558.28
0.46319 926.38
Salvage value 2,000
Total 95303.35 56833.56
NPV = ∑ (Total present value of all revenues) - ∑ (Total present values of all
investments).
= 56833.56 – 95303.35 = -38469.79
The net present value of the project is Rs. – 38469.79
Since the NPV is negative, the project will result in a loss and should not be
taken up
Centre for
Use of annuity
If the financial transaction (investment or revenue) is equal for n number of
years, calculation of PV for individual values can be avoided by using the
Present value annuity table. The Table gives the present value factor of
annuity of Rs.1 at specific rate of interest. This factor multiplied by annuity
gives the present value of annuity.
Centre for
PRESENT VALUE ANNUITY TABLE
Centre for
A project involves an investment of Rs 30,000 at the end of each year for 5
years. The returns are Rs. 25000 at the end of each year for 8 years. Calculate
the NPV. The rate of interest is 10%.
The factor for annuity for 5 years at 10% rate of interest is 3.79079.
Present value of investment of Rs. 30000 for 5 years
= 3.79079 x 30000 = Rs.1, 13,723.70
The factor for annuity for 8 years at 10% rate of interest is 5.33493
Present value of revenue of Rs. 25000 for 8 years
= 5.33493 x 25000 = Rs.1, 33,373.25
NPV = ∑ (Present value of all revenues) - ∑ (Present values of all investments).
= 1, 33,373.25 - 1, 13,723.70
= Rs.19, 649.55
Centre for
The financial outlay (in Rs.) of 2 projects is as under.
The rate of interest is 8%. Which of the projects gives higher profits?
Year
Project A Project B
Investment Return Investment Return
Initial investment
40,000 60,000
1
10,000 20,000 8,000 25,000
2
20,000 25,000
3
25,000 20,000 25,000
4
20,000 32,000 25,000
5
20,000 25,000
Centre for
UPES – The Nation Builders University Project A
Year
Annuity factor Present
PV of
Investment PV Factor Return for 5 years value of
investment
annuity
Initial
40,000 1.0 40,000
investment
1 10,000 0.92593 9,259.30 20,000
2 20,000
3.99271 79,854.20
3 25,000 0.79383 19,845.75 20,000
4 20,000
5 20,000
Total 69,105.05
NPV = 79,854.20 – 69,105.05 = 10,749.15
Project B
Year
Annuity factor Present
PV of
Investment PV Factor Return for 5 years value of
investment
annuity
Initial
60,000 1.0 60,000
investment
1 8,000 0.92593 7,407.44 25,000
2 25,000
3.99271 99,817.75
3 25,000
4 32,000 0.73503 23,520.96 25,000
5 25,000
Total 90,928.40 Centre for
Benefit / Cost Ratio
The benefit/cost ratio is also called the profitability index and is
defined as the ratio of the sum of the present value of future
benefits to the sum of the present value of the future capital
expenditures and costs.
Centre for
What is the benefit cost ratio for this project?

Centre for
Present Value
Annual Receipts Rs 40,000 Rs 226009
Salvage Value Rs 20,000 Rs 6439
Annual Disbursements Rs 22,000 Rs 124,305
Initial Investment (t=0) Rs 100,000
Present value of Receipts Rs 232448
Present value of Expenditure Rs 224305
Profitability Index 232448 / 224305 = 1.03
Centre for
Payback Period
One of the most common evaluation criteria used
Defined as the number of years required for the cash income from a project
to return the initial cash investment.
If the calculated payback period is less than some maximum value acceptable
to the company, the proposal is accepted.
Centre for

What is the pay back period for this project?

Centre for
Initial Investment: Rs 1,00,000

Initial investment = Rs 1,00,000

Annual return = Rs 40000
Pay back period = 1, 00,000 / 40, 000
=2.5 Years
Centre for
Financial outlay of a project is as under. Determine the payback period of the project
Period Investment (Rs) Return (Rs)
Initial investment 1,00,000
1 20,000
2 25,000
3 60,000
4 15,000
5 25,000
The payback at the end of 2 years = 20,000 + 25,000 = Rs.45, 000
For recovering, Rs1, 00,000, another Rs.55, 000 is required. However in 3rd year
Revenue is Rs.60, 000. We will use interpolation to determine payback period.
Total revenue in 3rd year = 60,000
Rs.60, 000 is recovered in 12 months
Rs.55, 000 will be recovered in (55,000 x 12) / 60,000 = 11months
So Payback period is 2years and 11 months

Centre for
Internal Rate of Return
Internal Rate of Return refers to the interest rate that the investor will
receive on the investment principal
IRR is defined as that interest rate which equates the sum of the present
value of cash inflows with the sum of the present value of cash outflows for
a project.
The calculation procedure involves a trial-and-error solution
Centre for
A project is expected to generate revenue of Rs 5000 annually for 5 years. If investment in the project is
Rs 19,000, determine the internal rate of return. If management expects a rate of return 10%, is the
project viable?
Present value of investment = Rs.19, 000
For an annuity of Rs 5,000 for 5 years:
Rate of interest Annuity factor Present value NPV

8% 3.99271 19963.55 963.55
9% 3.88965 19448.25 448.25
10% 3.79079 18953.95 -46.05
The investment being Rs.19, 000, the internal rate of return will be between 9% and 10%.
The internal rate of return now can be identified by hit and trial on various values of rate of
interest between 9% and 10%.
(1 + 𝑟)n r = 1.099 PV
1.0995 1.603 3118
1.0994 1.459 3426
1.0993 1.327 3767
1.0992 1.207 4141
1,0991 1.099 4548
Total PV 19000
NPV = 19000 – 19000 = 0
At a rate of interest 9.9 %

Internal rate of return is 9.99%
Since expected return is less than internal rate of return, the project is viable. Centre for
Numeric Models: Scoring
Profitability models focus on a single decision criterion i.e. profit
The factors for evaluation may include a number of non financial factors
Evaluation/Selection models that use multiple criteria to evaluate a project have

been developed.
Centre for
Factors affecting decision Marketing factors
• Potential market
• Potential market share
• Impact on current product
line
Production factors • Customer acceptance Miscellaneous factors
• Time required • Government safety
regulations
• Disruption in routine Personnel factors
activities • Government environment
• Training requirement regulations
• Effect on waste and rejects
• Skill requirement • Disruption in routine
• Energy requirements activities
• Skill availability
• Equipment requirement • Reaction of stake holders
• Resistance from current
• Process safety work force • Impact on share price
• Availability of raw materials • Impact on image with
Financial factors customers, suppliers and
• Change in output quality
• Profitability competitors
• Pay back period

• Cash requirement
• Size of investment required
• Cash flow
Centre for
Unweighted 0–1 Factor Model
A set of relevant factors is selected
One or more raters score the project on each factor, depending on whether
or not it qualifies for an individual criterion.
The ratings are summed
Projects with a sufficient number of qualifying factors may be selected.
Centre for
Unweighted 0–1 Factor Model
Factor Qualifies Does not

qualify
Time required √
Disruption in routine √
activities
Effect on waste and rejects √
Training requirement √
Skill requirement √
Disruption in routine √
activities
Reaction of stake holders √
Centre for
Factor Scoring Model
Factors are evaluated on a numeric scale
Centre for
Unweighted Factor Scoring Model
Factor Rating
1 2 3 4 5
Time required √
Disruption in √
routine activities
Effect on waste √
and rejects
Training √
requirement
Skill √
requirement
Disruption in √
routine activities
Reaction of √
stake holders
Project rating = 1 + 3 + 2 + 2 + 4 + 5 + 1 = 18
Centre for
Weighted Factor Scoring Model
When numeric weights reflecting the relative importance of each

individual factor are added, we have a weighted factor scoring model
Centre for
Weighted Factor Scoring Model
Factor Weight Rating
1 2 3 4 5
Time required 4 √
Disruption in 5 √
routine activities
Effect on waste 10 √
and rejects
Training 3 √
requirement
Skill 5 √
requirement
Disruption in 8 √
routine activities
Reaction of 2 √
stake holders
Project rating = 4x1 + 5x3 + 10x2 + 3x2 + 5x4 + 8x5 + 2x1 = 107
Centre for

Session 10-27.02.19 Project Selection

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UPES – The Nation Builders University

27th February 2019

Pay back Present unweighted Operative Product line

Net present Internal Rate of Weighted factor

T=0 +/- Cash Flows

For first transaction

For second transaction

Net Present Value (NPV)

The Net Present Value of an investment is the difference between cash

NPV = ∑ Present Value (Cash inflow) - ∑ Present Value (Cash outflow)

Initial Investment: Rs 100,000

What is the net present value for this project?

Initial Investment (t=0) Rs 100,000

Net Present Value Rs 8143

Greater than zero, therefore acceptable project

Year Investment (Rs) Revenue (Rs)

(Initial investment) 50,000

Salvage value 2,000

0 50,000 1.0 50,000

Total 95303.35 56833.56

If the financial transaction (investment or revenue) is equal for n number of

years, calculation of PV for individual values can be avoided by using the

annuity of Rs.1 at specific rate of interest. This factor multiplied by annuity

gives the present value of annuity.

Investment Return Investment Return

The benefit/cost ratio is also called the profitability index and is

defined as the ratio of the sum of the present value of future

benefits to the sum of the present value of the future capital

expenditures and costs.

What is the benefit cost ratio for this project?

Annual Receipts Rs 40,000 Rs 226009

Salvage Value Rs 20,000 Rs 6439

Annual Disbursements Rs 22,000 Rs 124,305

Initial Investment (t=0) Rs 100,000

Present value of Receipts Rs 232448

Present value of Expenditure Rs 224305

Profitability Index 232448 / 224305 = 1.03

One of the most common evaluation criteria used

Initial Investment: Rs 100,000

What is the pay back period for this project?

Initial Investment: Rs 1,00,000

Initial investment = Rs 1,00,000

Period Investment (Rs) Return (Rs)

Initial investment 1,00,000

The payback at the end of 2 years = 20,000 + 25,000 = Rs.45, 000

Revenue is Rs.60, 000. We will use interpolation to determine payback period.

Total revenue in 3rd year = 60,000

Rs.60, 000 is recovered in 12 months

Rs.55, 000 will be recovered in (55,000 x 12) / 60,000 = 11months

So Payback period is 2years and 11 months

The calculation procedure involves a trial-and-error solution

Rate of interest Annuity factor Present value NPV

At a rate of interest 9.9 %

Numeric Models: Scoring

Profitability models focus on a single decision criterion i.e. profit

Evaluation/Selection models that use multiple criteria to evaluate a project have

• Pay back period

Unweighted 0–1 Factor Model

A set of relevant factors is selected

The ratings are summed

Projects with a sufficient number of qualifying factors may be selected.

Factor Qualifies Does not

Factor Scoring Model