Calculations of cash Inflows with certainly:Year Project A Project BCash Certainly Certain Cash Certainly CertainInflow Co-efficient Cash Inflow Co-efficient CashInflow Inflow1 35,000 .8 28,000 25,000 .9 22,5002 30,000 .7 21,000 35,000 .8 28,0003 20,000 .9 18,000 20,000 .7 14,000Calculation of present values of cash inflows:Year Project A Project BDiscount Cash Present Cash PresentFactor @ 10% Inflows Values Inflows Value1 0.909 28,000 25,452 22,500 20,4532 0.826 21,000 17,346 28,000 23,1283 0.751 18,000 13,518 14,000 10,514Total 56,316 54,095Project A Project BNet present value = Rs. 56,316 – 50,000 54,095 – 50,000 = Rs. 6,316 Rs. 4,095As the net present value of project A in more than that of project B. Project A shouldbe preferred:(iii) Sensitivity techniqueWhen cash inflows are sensitive under different circumstances more than oneforecast of the future cash inflows may be made. These inflows may be regardedon ‘Optimistic’, ‘most likely’ and ‘pessimistic’. Further cash inflows may bediscounted to find out the net present values under these three different situations.If the net present values under the three situations differ widely it implies thatthere is a great risk in the project and the investor’s is decision to accept or rejecta project will depend upon his risk bearing activities.Exercise 15Mr. Selva is considering two mutually exclusive project ‘X’ and ‘Y’. You are required toadvise him about the acceptability of the projects from the following information.Capital Budgeting 139Project X Projects YRs. Rs.Cost of the investment 1,0,0000 1,00,000Forecast cash inflows per annum for 5 yearsOptimistic 60,000 55,000Most likely 35,000 30,000Pessimistic 20,000 20,000(The cut-off rate may be assumed to be 15%).SolutionCalculation of net present value of cash inflows at a discount rate of 15%.(Annuity of Re. 1 for 5 years).For Project XEvent Annual cash Discount factor Present value Net Present Inflow Rs. @ 15 % Rs. value Rs.Optimistic 60,000 3.3522 2,01,132 1,01,132Most likely 35,000 3.3522 1,17,327 17,327Pessimistic 20,000 3.3522 67,105 (32,895)For Project YEvent Annual cash Discount factor Present value Net PresentInflow Rs. @ 15 % Rs. value Rs.Optimistic 55,000 3.3522 1,84,371 84,371Most likely 30,000 3.3522 1,00,566 566Pessimistic 20,000 3.3522 67,105 (32,895)The net present values on calculated above indicate that project Y is more risky ascompared to project X. But at the same time during favourable condition, it is more profitablealso. The acceptability of the project will depend upon Mr. Selva’s attitude towards risk. Ifhe could afford to take higher risk, project Y may be more profitable.(iv) Probability techniqueProbability technique refers to the each event of future happenings are assignedwith relative frequency probability. Probability means the likelihood of futureevent. The cash inflows of the future years further discounted with the probability.The higher present value may be accepted.


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