(Submission-1)

by

WMP 08009 Davinder Singh

WMP 08022 Manish Kumar Singh

WMP08035 Rahul Yadav

WMP08036 Rajesh Ganvir

A report submitted in fulfillment of the assignments for

Financial management

WMP 2015

Indian Institute of Management, Lucknow

Noida Campus

Date: 30.03.13

1. Rainbow Products | : | | |

| | | | |

Scenario 1 : Purchase of Paint- Mixing machine to reduce labor cost| | | | | |

Expected Saving ($) | 5000| per year| |

Cost of machine ($) | 35000| | |

Depreciation in | 15 years| | |

Rate @ cost of capital| 12%| | |

A: Objective: Compute payback, NPV and IRR to decide whether Rainbow Products should purchase the machine or not.

i)Bay back: cost of machine/expected saving per year = 35000/5000 = 7 years.

ii)NPV = Difference between the present value of cash inflows and the present value of cash outflows. Thus,

NPV =-35000+5000* [1-(1/(1.12)^15]/.12

-35000+34053.31

NPV =-945.68

iii)IRR: It is that rate of interest that makes the sum of all cash flows zero.

0 =-35000+5000* [1-(1/(1+r)^15]/r

IRR =11.49%

Business Conclusion: Since NPV is -ve, Rainbow should not purchase the Machine.

B: Additional Info: Getting “Good as new” service for $500 per year, making the return on cash flows as $4500 per year in perpetuity.

Cash Flow ($)4500per year in perpetuity

Cost of machine ($) 35000

Depreciation in 15 years

Rate @ cost of capital12%

Additional Investment ($)500

i)Bay back: cost of machine/expected saving per year = 35000/4500 = 7.78 years.

ii)NPV = Difference between the present value of cash inflows and the present value of cash outflows. Thus,

NPV =-35000+4500/.12

-35000+37500

NPV =2500

iii)IRR: It is that rate of interest that makes the sum of all cash flows zero.

0 =-35000+4500/r

IRR =12.86%

Business Conclusion: Since NPV is +ve, Rainbow should purchase the Machine with the scheme.

C: Additional Info: Reinvested 20% of annual cost saving of $ 5000 back into new machine parts Which increases the cost saving by 4%in perpetuity to $ 4160

Cash Flow ($)4000per year in perpetuity

Cost of machine ($) 35000

Depreciation in 15 years

Rate @ cost of capital12%

Payback period in capital budgeting refers to the period of time required for the return on an investment to "repay" the sum of the original investment.

i) Pay Back : Between 7 and 8 years

PeriodReturnsTotal Recovered

1st Year Net cash flow40004000

2nd Year Net cash flow41608160

3rd Year Net cash flow4326.412486.4

4th Year Net cash flow4499.45616985.856

5th Year Net cash flow4679.4342421665.29024

6th Year Net cash flow4866.6116126531.90185

7th Year Net cash flow5061.27607431593.17792

8th Year Net cash flow5263.72711736856.90504

ii) NPV =-35000 + 4000/.12 - .04 = -35000 + 50000

Thus NPV = 15000

iii) IRR

0 =-35000 + 4000/r-g

IRR = 15.43%

Since NPV is +ve, Rainbow should go for the option of reinvesting the 20 % back into the business year on year since that brings the IRR above the rate of return of 12 % and thus is a viable option.

q 2. HOT dog concession stand

A. Given highest IRR = 1207.6%, the option to rent a larger stand is best. B. Given highest NPV = $34,825.76, the option to build a new stand is best. C. The NPV method should be preferred over here since it gives the total net worth that the company makes with alternative options. The other shortfall with the IRR method is the fact that it cannot be confidentially used in circumstances where the cash flow is inconsistent. While working out in such fluctuating...