Aman Limited is a leading manufacturer of automotive components. It supplies to the original equipment
manufacturers as well as the replacement market. Its projects typically have a short life as it introduces
new models periodically. You have recently joined Aman Limited as a financial analyst reporting to Ravi
Sharma, the CFO of the company. He has provided you the following information about three projects. A,
B, and C that are being considered by the Executive Committee of Aman Limited: Project A is an
extension of an existing line. Its cash flow will decrease over time. Project B involves a new product.
Building its market will take some time and hence its cash flow will increase over time. Project C is
concerned with sponsoring a pavilion at a Trade Fair. It will entail a cost initially which will be followed
by a huge benefit for one year. However, in the year following that some cost will be incurred to raze the
pavilion. The expected net cash flows of the three projects are as follows
Ravi Sharma believes that all the three projects have risk characteristics similar to the average risk of the
firm and hence the firm's cost of capital, viz. 12 percent, will apply to them.
You have been asked to prepare a report for the executive committee, covering the following:
(a) What is payback period and discounted payback period? Find the payback period and the
discounted payback period of Projects A and B.
(b) What is net present value (NPV)? What are the properties of NPV? Calculate the NPV of projects
A, B, and C.
(c) What is internal rate of return (IRR)? What are the problems with IRR? Calculate the IRR for
Projects A, B, and C.
(d) What is modified internal rate of return (MIRR)? What are the pros and cons of MIRR vis-a-vis
IRR and NPV? Calculate the MIRR for Projects A, B, and C assuming that the intermediate cash
flows can be reinvested at 12 percent rate of return.
Answers
Answer:
Aman Limited is a leading manufacturer of automotive components. It supplies to the original equipment
manufacturers as well as the replacement market. Its projects typically have a short life as it introduces
new models periodically. You have recently joined Aman Limited as a financial analyst reporting to Ravi
Sharma, the CFO of the company. He has provided you the following information about three projects. A,
B, and C that are being considered by the Executive Committee of Aman Limited: Project A is an
extension of an existing line. Its cash flow will decrease over time. Project B involves a new product.
Building its market will take some time and hence its cash flow will increase over time. Project C is
concerned with sponsoring a pavilion at a Trade Fair. It will entail a cost initially which will be followed
by a huge benefit for one year. However, in the year following that some cost will be incurred to raze the
pavilion. The expected net cash flows of the three projects are as follows
Ravi Sharma believes that all the three projects have risk characteristics similar to the average risk of the
firm and hence the firm's cost of capital, viz. 12 percent, will apply to them.
You have been asked to prepare a report for the executive committee, covering the following:
(a) What is payback period and discounted payback period? Find the payback period and the
discounted payback period of Projects A and B.
(b) What is net present value (NPV)? What are the properties of NPV? Calculate the NPV of projects
A, B, and C.
(c) What is internal rate of return (IRR)? What are the problems with IRR? Calculate the IRR for
Projects A, B, and C.
(d) What is modified internal rate of return (MIRR)? What are the pros and cons of MIRR vis-a-vis
IRR and NPV? Calculate the MIRR for Projects A, B, and C assuming that the intermediate cash
flows can be reinvested at 12 percent rate of return.