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ACCA I Advanced Financial Management (AFM) I Discounted Cash Flow Techniques - AFM Lecture 1

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Video Summary

Summary

Core Theme

This lecture introduces the Advanced Financial Management (AFM) syllabus, focusing on investment appraisal techniques. It emphasizes Discounted Cash Flow (DCF) methods, particularly Net Present Value (NPV), as the primary tool for evaluating projects, highlighting its alignment with the objective of maximizing shareholder wealth.

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assalamualaikum friends welcome to the

first lecture in AFM so the first

lecture in AFM is from your section b as

I've already discussed the syllabus of

AFM in my previous video

you will get it in the same playlist and

the AFM lecture

from June 2020 sorry September 2022 to

September 2000 or June 2023 okay the

name of the playlist and first uh video

will be on the syllabus and the changes

in the syllabus and the next will be

this one which is lecture one

so the lecture one as I told you

yesterday I'm going to start from

section two that is your advanced

investment appraisal all your Net

Present Value irr and maybe some new

techniques to value your investment

investment appraisal has already been

covered in your financial management but

here we are going to take it in an

advanced level with more features

okay so the topic is known as discounted

cash flow techniques why discounted cash

flow techniques because all the

techniques that you are going to cover

the Net Present Value whether your irr

whatever it is it is based on cash flows

it does not deal with profit or anything

you discount the cash flows you take the

time value of the cash flow okay

so let's start

what to focus on in this lecture we are

going to focus on these areas first we

are going to start with the Net Present

Value how to calculate net present value

uh also with the effect of inflation

taxation how to calculate net present

value very important question from the

point of your AFM you are definitely

definitely going to get a question on

Net Present Value there is no doubt

about it okay

you're definitely going to get it so you

have to be prepared for it no matter

what you have to know it there is not

whether it will come or not the thing is

it will come and how I can how I should

know everything about it okay Net

Present Value you have already also

covered in financial management but here

you will be learning more techniques

with the effect of inflation Taxation

and all those things next irr internal

rate of data thus also from your

financial Management's knowledge you

know how to calculate the interpolation

method okay again we are going to cover

it here okay but a small portion not uh

in a major portion and remember irr is

not only for investment operation it can

be used in your bond valuation in other

areas also from the other areas of the

syllabus that's why you have to be very

good in the formula and these formulas

are not given in your uh formula shift okay

okay

but the good thing is even for Net

Present Value and irr and the next mirr

we have a formula inbuilt in your excel

in your spreadsheet so you can use it to

save time but we'll come to that later

when I do a demonstration like when I do

questions on CB platform that time I'll

be showing you how to use this functions

okay for right now we'll be doing it manually

manually

because you have to know the manual way

by the way even if formulas are there

third discounted payback period you know

what is payback period how fast we

recover money from the investment this

is discounted you discount

as I told you the topic is discounted

cash flow technique all this whether it

is irr net present value payback period

all this are dealing with cash flows

only one thing is common cash flow okay

by callow duration

this is something new we'll see not very

difficult very easy okay formulas are

there okay the formula is given will be

given to you in the formula sheet

multi-period Capital rationing what we

have done in financial management was

single period Capital rationing now we

are moving on to multimedia that means

more than one year when you are having

this limitations of capital how to deal

with it this

for in this year's syllabus only we have

to discuss that's it only the discussion part

part

okay nothing to solve no calculation

will be asked on this area

Monte Carlo simulation and sensitivity

analysis you don't have to do simulation

if you know what the simulation is you

just have to discuss on those areas this

is also something which is very very

important for your AFM okay we'll go

through it what is uh simulation Monte

Carlo simulation is basically you see

different scenarios and see what is the

impact it could be on anything maybe Net

Present Value if this figure changes

what Net Present Value how much net

present valuable for or increase

basically that is what we do simulation

you look at this different types of

scenarios and this could be done very

quickly in Excel rather than going manually

manually

but you don't have to know the Excel

thing and all for Monte Carlo simulation

because you are not supposed to carry a

simulation for your AFM exam you only

have to know the discussion part of it

and sensitivity analysis also is very

similar okay but due to some limitations

of sensitive analysis we do Monte Carlo

simulation sensitivity analysis is

basically you just change one variable

and see what is the impact on

the output

Monte Carlo simulation can change many

variables at the same time and see the

impact on the output

we'll see that we'll see that okay and

finally we are going to conclude with

the value at risk okay

even if the term looks new to you you

don't know what it is don't panic I will

be taking you through the basic level I

will be explaining you okay assuming

that you don't have zero knowledge of

this AFM is the new subject I'll be

explaining from the 0 11 okay so no need

to worry at all I'm not going to use

some technical words or jargons or

something like that

okay so let's start with Net Present Value

Value

that Princeton value is the simplest and

also the best

okay in terms of valuing any investment

let's say you want to invest in a

project how do you know which in let's

say you are a financial manager in a

company you are given this that you have

three four projects now you have to

select which projects to take obviously

we know that if our Net Present Value is

positive we accept projects but we also

know that funds are limited we don't

have unlimited cash or something that we

can accept all the positive Net Present Value

Value

right we have to make some choices over there

there but

but again

again

the thing is what you have to know is

how to do the calculation part in The

Net Present Value okay to reach to Net

Present Value there is a there are

lengthy of you do it in a tabular format

and this you can do it in Excel okay I

would suggest you to return Excel rather

than word on your CBA platform

okay and if you don't know what is a CV

platform how it looks like let me tell you

you

all your professional level papers even

your F level papers professional papers

will be computer-based examination no

more paper system okay so you have two uh

response like you can write your answers

into format one you can use word the

other one is you can use Excel it will

be there I will show you the demo also

how it looks like in Excel basically you

do calculations okay lengthy

calculations I will suggest you to do it

in Excel

because the formulas are there you can

quickly carry forward to the next cell

word basically for typing and all okay

so you have to use both okay

that's whatever

so now Net Present Value calculations

use Excel okay and Net Present Value

calculations let me tell you

most of the time it it can come as a 25

marks question if you have gone through

my syllabus by the way you know paper is

three questions first question 50 marks

the remaining two questions 25 marks

each okay so it can come either in

section as a 50 marks question or in

section B is a 25 marks question if it

comes in section A as a 50 marks

question remember there are so many

calculations you have to do okay the

thing is not so long the thing is how

you handle the information and how you

handle the calculations because it's

very easy that you might go wrong somewhere

somewhere

what you need to do is just keep going

forward do your calculations do your

work working since to be done lot of

workings lot of calculations we'll be

doing questions also in fact don't worry

to show how a question looks like we are

going to start from a simplest question

and then we are going to build more and

more and more impact on that and then we

are going to reach to the final stage

where we are going to do exam style

questions on Net Present Value okay

we know the net present value is

positive we accept the project if it's

negative we do not accept the projects

okay best technique is net present value

why I am telling best net best technique

is net present value because there are

so many other techniques also irrmirr

discounted payback and all where you

have to Value all evaluate which one is

the best sometimes you have to write

discussion part also it's not just it's

just not numbers numbers even if I say a

net present value is mostly numbers five

or six bucks you might get discussion

bottles to discuss why Net Present Value

which technique is best

then you can write this as an answer

time which I'm telling you the net

present value is one of the most

prominent and most uh the in terms of

quality that's the best to evaluate your

capital investment projects why

you have to know the why because you are

the one who are going to write the

Sounds in the exam

so ask ask the question why don't just

memorize okay Net Present Value is the

because examiners I will tell you they

will twist the question and they will

ask you why Net Present Value is the

best why not the others the reason why

Net Present Value is separate from

others the differences C remember the

fundamental objective of financial

management it is to hold you objectives

obviously there are the objectives

maximize profit maximize sales maximize

this maximize that those are okay keep

them aside

number one thing you have to remember

it is the same for financial management

also it was the same thing Advanced

Financial Management also is the same

thing maximize shareholders wealth so

you maximize shareholders wealth when

you accept projects that gives you net

positive Net Present Value understood

that's why Net Present Value being

positive is highly correlated with your

maximized in our shareholders wealth

which is your objective also

that's how you know that you are

maximizing the value for the shareholder

through having projects which have

positive Net Present Value understood

I took a long time to explain that one

fundamental principle because all your

Advanced Financial like whatever the

topics you are going to cover hereafter

till I finish the AFM syllabus is based

on this one fundamental principle

whether you manage a risk through

current service or interest risk whether

you go for an accusation whether you go

for a reconstruction whether you advise

all these things is based on one whether

it is maximizing the shareholders wealth

or not if something is maximizing

shareholders well you go ahead otherwise

you reject that's the only thing that is

your uh

what do I say litmus test to know

whether you're going to accept the

project or not shareholders well is

maximized or not that's it you

understood this much AFM is nothing it's

very easy

because I want to make AFM in your

mindset I want to make you feel I want

to make it sound like AFM is not

something which is very technical so

much of excess calculations Excel these

that should I know excel at Pro level

should I be Advanced no nothing like that

that

even if you're at the beginner level you

know nothing about Excel cool you still

can survive AFM you still can pass the

FM with very good scores but make sure

you learn your Excel also that you can

do on your own also

update your Excel skills because being

in the world of Finance you should be a

pro in Excel but for your exam if I'm

exam no it's not required

I mean you should do basic things you

should know how to do some functions how

to do uh subtract how to multiply

division these things you should know

okay this thing's in Excel you have to

you should know it because you have to

do it in here but other than that

IF function or function and function uh

rank this thing is not required at this

level they will not be asked okay so

fair enough things are cleared so ifm is

not something very difficult yes but you

need to work consistently you need to

work hard you have to do a lot of

calculation questions from the very

beginning that's the reason I have

chosen this topic

as my first lecture rather than starting

in the order of the syllabus section A B

C section A is basically a theory part

that I can explain you that will be the

that I can like basically just tell you

in the last as the last lecture maybe

last few lectures will be on that

that is a financial senior financial

advisor like they are advising you on things

things okay

okay

so let us start with this okay

Net Present Value is the best for

investing capital investment projects

okay what do you do you basically take

the cash flows take cash inflows and

take care of those and discount them and

deduct your cash out close from your

cash and close

and get your value that is known as Net

Present Value in simple terms okay

caching flows will be given to you in

the exam cash outflows will be given

during the exam discounted will be

sometimes given to you sometimes you

might have to calculate how you have to

calculate for that also we have in the

upcoming lectures we'll be covering that

also which is known as your cost of

capital or vac weighted average cost of capital

capital

that also you have to know how to

calculate okay

so that's the thing discount rate

so using that discounted discount

caching flows outflows deduct outflows

from inflows and get your value that

which is what is known as Net Present

Value that's it

looks very simple actually it's not so

simple because there are plenty of

calculations you have to do you have to

take care of everything if you want to

get that perfect Net Present Value but

let me tell you one piece of advice

don't focus on so much of getting that

one Net Present Value figure correct

make sure that you arrest other figures

are correct your workings are correct so

that even if at the end something

happens let's say you have taken a wrong

discount rate or cash inflow one figure

went wrong

don't worry Don't Panic don't go and try

to change the favor if you have time do

it if you don't have time don't

Just go with it because your marks will

only be cut once for that incorrect this

thing not twice that your net present

value is wrong and then your working is

wrong no only once you'll be penalized

but as long as you have that table you

have the workings with you you will get

the maximum amount of marks so try to

work on that maximum amount of months

rather than trying to perfect to get the

Net Present Value figure correct because

let me tell you the reality very rarely

people get Net Present Value correct

very rarely but still they manage to

pass AFM okay you will ask me how do I know

know

because one of the student is me

yes you will not believe one of the

student has made I got this question as

a 50 mask question

and I did many uh mistakes in fact in

the table

in the cash inflows and outflows my

sales figure I think went wrong my uh

working capital figure went wrong I

think I realized it very soon but I

didn't go and change it I just went with

that wrote The Net Present Value with

that I gave the conclusion and wrote my

uh wrote my uh this thing also

report also with that figure still I

managed to pause with 60.

60 you will not be left sixty percent so

it's not about getting that one right

figure don't try to perfect your answer

in FM you can never do that I'm telling

you this

repeating these things because a from

people think because it's like more like

math more like calculation so we can get

100 also

I'm not saying you cannot get 100 but

don't try to force too much because your

other areas might suffer you might get

other things wrong rather try to cover

the question and do it whatever the time

is given to you you can use it to the

maximum do all your workings okay make

sure workings are there at least because

you'll be getting marks not just for

that one Net Present values not that you

use your calculator for everything and

just with the Net Present Value only in

the Excel no

or for every step you're getting marks

by the way this question can come as a

30 marks 20 Mass question also Net

Present Value the calculation what I'm

talking about discussion part is a

separate marks so for calculation itself

is 20 30 marks you cannot expect just to

get one mark for the Net Present Value

losing another 29 marks for the workings

you need to have workings at each stage

you are getting Marks One Mark each okay

okay so

some basic networks and value concepts

are that one is you should know it has

relevant cash flows cash flow has to be

relevant what is this relevant cash

flows we are going to comment in the

next slide you cannot include all types

of cash flows remember that we are

saying cash flow but not all are

relevant cash flows are Net Present

Value number two discount which array to

use you might be given two three rates

to confuse you you have to know you have

to be very wise enough to choose the

correct discount rate by the way how to

do it let you know okay so impact of inflation

inflation

yes as you know cash flow okay cash flow

the purchasing power keeps reducing why

because inflation every year inflation

increases and what are we doing we are

predicting sitting here that this

project will bring me four years five

years cash flows we predict but what's

about the next year after that after

that year cash flow the value of the

cash flow will not remain the same why

inflation did we take account of

inflation in the picture no but we have

the impact of inflation it affects the

value of the gas flow amount of the cash

flow that you're going to receive in the

future next is the last is foremost

important is impact of Taxation

tax will have an impact on the capital

isn't it because you are paying tax okay

okay

how are you paying tax

has nothing to do with profit it will

reduce your cash flow

that's why you have to take the impact

of Taxation

and one might ask

if I get a question on Net Present Value

how do I know whether it is an impact of

inflation or impact of Tiger Wood see

all together will be given to you in one

question only it's like everything

that's why you have when you're studying

study separately one area but when

you're doing a question when you see

your revision kit questions also

everything comes in one question only

you understanding that's why you have to

be Pro singly individually learn One By

One impact of completion that's why we

have a separate question also okay on

that and then we are going to do one

major question which includes all impact

of Taxation also will be the inflation

also will be their discounting rate also

will be there relevant cash flow or not

also will be there okay

and don't worry tax rate will be given

to you inflation days will be given to

you the years at which it is impacting

will be given to you everything is given

to you basically all the tools and

resources are given to you you have to

know how to use it it's like a recipe is

given to you you have to know how to

make the curry

that's just as simple as that okay

now relevant cash flows basically what

are the relevant cost and revenues cost

means your outflows revenue is your

influence sales and cost okay it could

be any cost maybe variable cost fixed

cost any other cost okay basically the

revenues if you talk about if you have

if you have seen the papers or not I

don't know revenues are just one or two

times maybe your commission or your

sales mostly sales revenue but there

would be other types of revenues also

okay they are known as cash inflows

because that is the first thing that you

write on the table also you first write

inflows or outflows inflows you start

with the revenue

okay so what are this relevant cash flow future

you cannot just include any types of

cash flow by the way cash flow which are

passed which has nothing to do which you

are anyway going to incur whether you go

for this project or not are not relevant

future why future because in the future

cash flows are important cash inflows

which are coming in the future cash

outflows which are going to go in the

future are relevant cash flows you have

to take them in your networks and value calculation

calculation okay

okay

second whether it's future or not it

will be given to you directly they will

write you okay then in year two three

four this is the caching flow this is

predicted the things like that they will

write maybe they will not write future

but they might write in year two three

four uh they predict this much of cash

inflows or that much of cash outflows so

through that you know this is Future okay

okay

relevant cash inflows and outflows only

mostly they will obviously they have to

give otherwise how are you going to do

in that present value but you just have

to find out which are not relevant don't

take those that's it eliminate those

most is relevant only okay that makes

your work very simple by the way next is incremental

incremental

incremental means something because of

the project it is happening

it is added

because of this project that you're

going to take if you are not going with

the project let's say because of this

project you have to hire now extra stuff

only for that project there's skilled in

that so that is a relevant cost for you

because for that project rule your take

otherwise you would have not incurred

that cost but normal salary is tough and

all which who are there already

that you don't have to calculate

okay now

some basic networks and value concepts

are revised as follows you should

therefore ignore you should ignore this

so This are the two relevant one is

feature one is incremental but what

should you ignore then ignore sunk cost

if at some cost they will tell you it's

a some cost cost like market research

cost or uh you have done some survey

some questionnaires this is some cost

why this has been done in the past you

cannot recover this course now from the project

project

for example to go with the project you

must have done some market research you

must have asked the people you must have

done some questionnaire they are some cost

cost

you cannot recover them so you ignore

them do not include

committed cost okay

okay

ignore usually they will not give

committed costs but if they give they

will write it that this is a committed

and non-cash items as I told you Net

Present Value calculations everything is

casually if it's not cash you do not include

include

a portion overheads overheads and all

you don't include

abortion overheads okay

so these are the four areas ignored okay

next let's start with the impact of

inflation in your Net Present Value only

but before that you have to know that

you have to know one small formula this

formula will be given to you in your

formula sheet but you have to understand

the Formula First just memorizing will

not help you okay there are two dates

why I am telling you this because

the amount the the discount rate that

you are going to choose to Discount your

cash inflows they might give you both of

the series you have to know which area

to use okay let's let's start right so

there are two reads

according to Fischer formula

one is known as real rate the other one

is known as nominal rate what is this

feature formula what is nominal real

rate I am sure from your financial

Management's knowledge you know what I'm

talking about okay

okay

but again just to revise

assuming that some of you might have

even got Exempted

but anyway you must have done it in your

financial management courses in your

degree level or anything but let's

assume that you have forgotten let's

keep it fresh and

so we'll again revise it a little bit

this is known as Fischer formula

only one formula is given to you

okay that is the first one

after all the second line uh that they

have changed the subject that's it in

your formula she you will see the first

Formula only the first line 1 plus I

into one plus r into one plus h what is

this I what is this R what is this h okay

okay

and what is this real rate nominal rate

and all

first of all you need to know is R

stands for real rate

I stands for you can say money rate or

nominal rate remember the two terms

sometimes you might get confused

sometimes they might give I

saying is a money rate you might take it

as a real read so no real rate is r i

could be money or nominal rate and H

why did I give you this

sometimes sometimes your cash flows that

is given to you might be not inflated

okay when it is not inflected

that means you have to use the real

discount rate let me repeat no inflation

use real discount rate

to discount if it is inflated which is

the which is the normal exam style

question your AFM exam questions are

nominal rerolly not really I don't I

didn't see any questions where it was

real rate that you have to use to

discount but anyway

you inflict the cash flows because

obviously inflation will be given to you

in the exam you have to inflate the cash

flows right so that's a normal scenario

so cash inflows are inflicted then you

have to use nominal rate then you cannot

use real rate you have to use nominal

discount rate to Discount your cash

flows understood no inflation real

inflation nominal

and what is general inflation rate will

be given to you in the exam they will

give you see at least two figures they

have to give you to find the third

figure your understanding missing is

like missing uh fill in the blanks the

missing figure that you need to find out

that's why this why this formula is

given then if they are giving you both

the rates sometimes sometimes they might

not give you both the rates they might

just give you one right and one

inflation you might have to find the

third rate suppose

suppose your

your

your cash inflow is inflated okay

what rate can you use nominal rate but

nominal rate is not given to you but

indirectly you can find out how real

rate is given to you inflation is given

to you so you know the feature formula

through the feature formula find the

nominal rate and then use that nominal

rate to Discount your cash flows

understood I might be a little fast but

anyway with questions you will

understand this better

your understanding that's the reason why

this feature formula is useful for

understand the importance of formula

when to use and when not to use okay

okay

inflation General inflation rate they

will give to you your only thing is

either you have to find the r that is

real rate either you have to find the

nominal rate in the exam sometimes you

don't have to find sometimes it's just

given to you you don't even have to find

also so if both are given don't use the

feature formula to find out again to see

whether it's correct or not don't waste time

time

if both are given don't worry if one is

given but you need the other one not the

one which is given then use the feature

formula sometimes the one given to is

what you need so you don't even have to

waste time to find the other one understood

understood

like cash influence are not inflated

real rate is given to you so you study

already no need to use to find the

nominal rate okay

okay and

and

you have to know how to change the

subject let's say in the first line it

is 1 plus I

so basically we're assuming you have to

find I that is nominal rate second one

if you want to find the real rate

take the real rate on one side keep it

in the side it is because otherwise if

you bring it to the left side it becomes

negative R becomes negative so 1 plus r

keep it but bring one plus h to the

other side so multiplication becomes

Division 1 plus I divide by 1 plus h you

understand it you should know this

change okay this is basic level of math

that I cannot teach you now you have to

learn it on your own okay you bring on

the other side

the sign changes multiplication becomes

division division becomes multiplication

if it's addition subtraction addition

becomes subtraction subtraction becomes

addition understood okay

now impact of inflation so calculating

free cash flows of a project and inflation

inflation okay

that means impact of inflation must be

taken into account when calculating the

free cash flows to be discounted we know

okay you have to take this impact of

inflation in your cash flow that means

you have to inflict your cash flows next

remember this can be dealt in two ways

the impact of inflation but both methods

will give you the same Net Present Value

now in your exam both methods will not

be asked don't waste time to see whether

my Net Present Value is correct or not

using both methods either one method you

have to use

okay what is it one is known as real

method the other one is known as

nomination the nominal method

in according to my understanding

what I have seen in the past

the rate that they have used is the

second method nominal method only they

have used that means you have to employ

the calcium Clause okay because you are

not serial method why am I saying it

because if real method is used that

means you don't imply the cash inflows

so if you don't inflict how do you show

the impact of inflation that is the

whole point now to show the impact of

inflation in your AFM

so real method they don't use but know

that you can use real method also by

using real discount rate to Discount

your caching flows okay

okay

but there are limitations real method

can only be why don't we use real method

in the exam because real method can only

be used when

or your caching flows are inflecting at

the general rate of inflation that means

all the calcium flows are inflicting at

the same rate of inflow uh inflation

some are inflicting some are not

inflicting how can you use real method

all has to inflict at the same rate

General rate of inflation then only you

can use real method then it's applicable

but in your exam you see your sales are

inflicting at one figure your costs are

inflicting at the other figure which is

actually your actual exam is like that

if you see go through it sales are

inflicting on one figure five percent

let's say fixed costs are inflating and

three percent so you use nominal method

not real method will not work

now in questions involving specific

inflation rates yes you are more likely

to use the second method in your AFM

exam remember that but that does not

mean you should not know the first method

method

what if the first method comes out of

the box for you you should always think

out of the box and be privacy always be

prepared for the worst just because

something does have never come does not

mean for you it will never come

okay keep this mindset if you keep this

mindset you will always be at The

Winning Side whatever the question comes

in FM be prepared for everything you

know this also you know that also so if

this comes you can deal with it with if

that comes also you can deal with it

okay just don't go with the nominal

method and you know but yeah work mostly

on the nominal side because

I'm telling you from if you have seen

the paper and also past experience yes

nominal method has been a Serial method

I didn't see any single question where a

real method has been asked

so where specific inflation rates are

money method is more reliable nominal

method okay

now go through this table this is the

summarization of what I've explained to

you this is the summary

on your left hand side you can see real

method right hand side you can see the

nominal method both are

methods of dealing with inflation the

way of presenting Net Present Value but

Net Present Value remember will be same

under both the method

why how it is same because for real you

are not inflecting so you are using real

discount rate for nominal you are

inflicting you are using nominal

discount rate discounted rate is even

lesser than the real method so both

should give you the uh same Net Present Value

Value

if it's not something is wrong but you

don't have to do it to check only one

method is asked like they will not say

use nominal method in the exam directly

like that but they will give you inflows

sorry uh inflation things like that you

will know which one to use okay

okay

so just know real method use real

discount right uh nominal use nominal

discount rate that's it that's the only

thing you have done so before I go to

the next

slide letter uh let us do a question

where we are including everything impact

of impact of inflation before we go to

the impact of Taxation

okay because I told you at every step

we'll be doing questions before we do

one final question which includes impact

of everything inflation taxation

discounting everything so this is only

with inflation no taxation we didn't

take it into the picture here impact of

inflation so let us do a small test

test your understanding one this is the

first ever question that you are going

to do in AFM okay so while you are doing

a question

okay just make sure that it's not the

answer only that you need to get it

correct see the pattern of the question

how it looks like how the figures are given

given

why because in your real exam this will

be the exact very similar nature your

questions will be given to you if you

know the format of the question the

layout of the question you can read faster

faster

P you will be able to uh save a lot of time

time

because you exactly know the format what

comes after what right

right

so try to improve on those two areas as

well you need to read fast and you need

to understand the main information very

quickly because lots of figures will be

given to you numbers

in between the text

okay so but it's okay this is your first

question so obviously in this you will

take a lot of a lot of time to do it

because first you need to understand the

layout okay once you start doing

questions repetitively on Net Present

Value you will know that it follows a

similar pattern which makes your work

very much easier right

and this question is net present value

with inflation

okay later we are going to take taxation

also but we do not have taxation at the

moment this is without taxation okay we

are taking one variable at a time we are

adding with it and finally we'll be

doing a question a full-fledged question

on Net Present Value where we have all

the variables inflation taxation okay

so what is the requirement the

requirement does always start with the

requirement first okay what you are

required then you go to the case study

100 that is the format of that is the

way you do questions in

it is you

Focus the free cash flow of the project

okay understand the terms free cash flow

of the project and determine whether it

is worthwhile using the net present value

value

okay basically you have to find the Net

Present Value but before I do a question

note that in the CBE because you are

going to give your exam on a

computer-based examination

you can use Net Present Value

spreadsheet function to save time here okay

okay

since this is your first question so I

thought rather than taking you through a

CB platform first let us do manually

because you need to understand the way

we do it okay then it's not a matter

whether you do manually or in the Excel

set but first you need to understand so

this is this is the first lecture all

the questions we'll be doing

or you can say all the questions that we

have in your textbook under your test

your understanding we'll be doing it on a

on the OneNote manually but your

revision kit questions I will be doing

it on a CV platform okay

okay

that's there so you will get the

practice on the CB platform from way early

early

rather than waiting till the last moment

because this is a question most students

often ask me ma'am should I wait till I

do like till I finish do my mocks

finally in the CB platform no while you

are practicing Your Efficient good

questions you have to touch you have to

start with the CPU platform because

there's no use of doing it manually yes

but your initial time when you're

starting the subject you need to do it

manually because you need to understand

how the things are done

okay so there is a Net Present Value function

function

in your Excel you write Net Present

Value everything is there you get it I

will show you that on a zero platform

okay now it's too early first you need

to do you need to know how to calculate

net present value manually okay

okay so

company invest 7 million okay always

when you are doing a Net Present Value

okay you need to know what is your info

what is your outflow

okay it makes your own very easy this is

an investment you have to invest as an outflow

or you can even write a negative sign

next to it

outflow okay net contributions over the

next five years please make sure you

know the duration because it's a project

not one year not two years it's a long

term project

it will be usually three four five years okay

okay

net contribution over next five years is

expected to be 4.2 million per year in

real terms just now we went through real

terms and nominal terms you need to

understand so this is 4.2 what is the

meaning of real terms here

that means this 4.2 million has not been

inflated you have to put inflation into it

okay that means first year second year

third year fourth year fifth year it's

4.2 unit template is it possible in real

life no

can it be 4.2 all the five years no

because of inflationary changes next we

have and this is an inflow net contribution

then we have marketing expenditure of

1.4 million per year which will also be needed

needed

okay see whether it will be inflated or

not inflation rate will be given to you okay

okay

there are two types of inflation we just

went one is specific one is General if

it's General it will affect everything

if it's specific specifically they will

tell you this is the inflation for

marketing this is the inflation for the

net contribution so marketing

expenditure this is an outflow again

So currently you have two outflow one

inflow expenditure of 1.3 million per

year will be required to replace the

existing assets

which will now be used

on the project but are getting at the

end of their useful life

which expenditure is this this is the depreciation

this expenditure will be incurred at the

additional investment in working capital

equivalent of 10 of contribution this is

how whenever they give you any working

capital expenditure this is how they give

give

10 percent of the sales 10 of the

contribution okay percentage could be

anything but it would be percentage of something

something

will be needed at the start of each year

you need to know why they have given

this specifically I will show you why

when we do the answer why they told

specifically a start of each year okay

working capital yes they will be

released at the end of the project

whatever you have invested from the

start and the end here the fifth year

you will recover all the amount

okay so when you go through your real

exam also

okay this is the same way in nature

things will be given to you

okay working capital will be there uh

investment in non-current assets will be

there some variable expenditure like

here it is the marketing X-Men teacher

maybe more expenses they can give you

okay or inflow also could be more than

once not necessarily contribution you

might get a royalty payment things like

that and obviously your initial

investment is there so this is the same

very nature things will be given so like

every time it's repeated if you see just

the figures are changed

and the company is changed okay

now they have given you the rates of

inflation also for the next five years

contribution eight percent you see

inflations are different that's why you

differently need to inflate this is

called specific inflation rate marketing

is three percent assets is four percent

General prices is 4.7 percent

now we'll go through the general prices

I will tell you why it is given

the real cost of capital is six percent

all cash flows are in real terms ignore

tax for currently yes but in real exam

tax also will be given to you that you

cannot ignore now tell me

because this is a Net Present Value

question you need a discounting factor

or not

any net present value equation it's a

discounting factor or you can say cost

of capital to discount

what will be that discount of factor

fill the discounting factor be six percent

percent

I'm asking you this it's the real cost

of capital

if if

you are saying it's yes

then you need to go back and revisit

your uh lecture

lecture

what I have discussed that means you

have not understood the concept if you

are saying no we need to find out the

cost of capital then that means you are

on the track you are with me you

understood okay so it's a no

why this is real cost of capital my dear

friends and what is given to you is

within you are going to inflate that

means it will be in the nominal term so

for nominal terms cash flow you cannot

use real discount rate you have to find

nominal discount rate how are you going

to find the nominal discount rate it's

not given

you can find out what

see in AFM when you're stuck this is

from very beginning I'm advising you

okay you will never get stuck anywhere

you should never get stuck there's

always a way out remember that okay

whenever you're stuck somewhere in AFM

okay in the exam you think that the

figure is not given to you how do I find

Don't Panic there will be try to find

out in it in an indirect way maybe

things are not given directly but there

will be something that is given to you

some information is given to you through

which you can find out

AFM is always designed in such a way you

will never be stuck that is the beauty

of afam

if you know that

you will never get stuck you will never

Panic also because you know there is

always a way also try to find that way

out rather than panicking and breaking

your head to find that figure which is

not there it's not there but there's

another way what is this that's why I

have highlighted General prices General

prices is your inflation

so through this 4.7 percent you have

been given General inflation you have

been given real cost of capital what

else always try to get a Formula Four

Wheelers are very useful if you have to

find something in an indirect way

remember you have to make use of the

formula that is the simple meaning of it

one formula we have just studied what is it

Fisher's equation right Fisher's equation

so what does it say

we are going to make use of it first

find that you can do this at the end

also it does not matter first you find

all the cash flows when you come to a

discount then also you can find out or

you can find out from very before and

keep it

okay anyways it's okay but make sure you

have you find because I usually say find

this in the very beginning of the

equation why because number one

towards the end when you start doing

cash flows and all

you might run a short of time sometimes

you might sometimes forget also that you

have to take a different discount rate

you might sometimes just take the six

percent it's very easy for you to forget

under the exam pressure

and another thing is sometimes you know

that cash flow is wrong again you have

to correct it takes a lot of time to do

that cash flow it's not easy

so finding this is very simple so I

always say that find it in the beginning

okay simple things needs to be done uh

way before you go into the complex issue

next actually started doing the cash

flow there are so many cash flows to

deal with your variable cost you have

fixed calls you have marketing you have

country things are there

so we'll find out this first okay what

is the formula

one plus

n n is your nominal rate right

or I sorry it was 1 plus I not nominal I

stands for the nominal rate that's what

you want to find out equal to 1 plus r r

is a real discount rate okay 1 plus r

into one plus h

R is your this is the formula you're

using okay

and H is your inflation that is your

General's price

so what else you know R you know H isn't

finding I easier two variables are given

just feeling it's like

uh you are filling the missing figure okay

I you keep this side

1 plus h into one plus

R okay minus 1 because plus 1 is this

side take it to the other side it

becomes minus one okay just change the

sign okay when you take something to the

other side plus minus minus minus

becomes plus when is for multiplication

and division this is math I'm teaching I

should not be doing it but anyways never

mind maybe for some people it might be helpful

helpful

so multiplication becomes Division

division becomes multiple uh multiplication

multiplication

know this straight away okay because

sometimes students take the plus as

multiplication when they take the other

side or division also that should not be

the thing plus minus multiplication division

division okay

so now I

what is the what is the inflation 1 plus

h one plus four point seven percent

obviously when you're putting in a

calculator or in an Excel you can put

the decimal places okay 0.047 into 1

plus 6 percent

minus one put it in your calculator and

find out what is the figure

you should be able to do it

and this thing should not take more than

one minute or maybe I will say 30 seconds

it will be 0.109

make sure you get this figure if you

don't get it stick to it make sure you

have to get this figure

until you are not able to get this

okay

if you convert this in terms of

percentage it will be 10.982 percent to

be exact but in AFM round it up to the

whole number okay whole figure

so this will be 11 percent

11 is your cost of capital

just getting the figures not

the only step after this there's one

more step check whether you are correct

or not technically maybe number wise you

might be wrong somewhere but technically

whether you're right or not how do you

check it

this is what your nominal discount rate

what is your real discount rate six

percent your nominal discount rate

should always be greater than your real

discount rate

sorry the other way around

your nominal that is your eye should

always be greater than your six percent

greater than r that is six percent

eleven percent is greater than six

percent so that means this is

technically right

imagine if it was the other way around

if I was five percent or four percent

then you know somewhere you are wrong

definitely you are wrong this is your

warning sign and this is the beauty of

AFM also because you know whether it's

correct or not it's easy to check out okay

okay

so this is eleven percent now this is

correct y I should be greater than R

because I is with inflation remember

when inflation is there

it's more Escape

more risky that means cash flow

you are getting less cash flow

purchasing power your purchasing power

is reducing okay

having a higher cost of capital means

your project is now more risky you will

receive less cash flow try to Discount

with 11 and try to Discount with six

person which one is giving you less cash

flow eleven percent understanding

understanding

having a high cost of capital is not

good so I is with inflation that's why

it's greater than r r is without

inflation so it will be less than I

understood this makes sense you know

eleven percent so you have to but you

don't need this figure at the beginning

when you

put all your cash inflows and outflows

and deduct overflows from implos and get

your net cash flow that is the time you

need this 11 keep it aside

okay now start

what should be a starting point

before anything before putting in a

figure you need to understand what

you're writing how many columns you need

to make

this is manual I'm teaching you between

CB platform you don't need to do all

those things Excel is already there but

you still need to know how many columns

you need and what things you need to

write in that Excel and how to start

what is the starting point

starting point is my dear it is always

your inflow

your sales but here

if you see net contribution is given to

you not sales

okay that means they have already

deducted the variable cost from sales

and they gave you the net contribution

so your starting point is net contribution

contribution

okay starting point after this all

inflows right in the beginning after it

gets over write all your outflows deduct

discount that's it

okay but here they told the project is

for five years okay you need to know how

many columns I'm going to show you this

okay you always need to start with year

zero t 0 means year zero always

always

weather project is for four years or

five years always one extra because that

one extra is year zero you have to start

with year zero zero

zero right

right

zero one two three four five how many

one two three four rather than me doing

it I'm showing you here so that it saves

your time as well as my time understanding

understanding

the thing is I'm not doing it from

scratch because it will take for me to

write it write the figure one by one in

the column it waste a lot of time for

you also okay

but yeah you definitely need to do it on

your own you cannot put on this table so

columns is there one column is for

description you need to describe you

need to write it okay this will be Excel

okay so how many one two three four five

six seven

one is for your description starts then

zero one two three four five and make

sure that if you are dealing in millions

okay you can drop down the three zeros

always it's good to drop down the three

zeros I have done the same in my exam it

saves you a lot of time in entering the

digits because dealing with small

numbers always easier than dealing with

big number

you can easily get a incorrect figure or

you can add one additional or one less

zero then if you're dealing in millions

rather drop down to three zeros like here

here

and write the currency also here's a

dollar so

and by the way in your CB platform you

can deal with three uh four to five

currencies only it's okay it's given there

there

Japanese Yen dollar pounds Euro I think

one else is there I forgot but anyway

currencies are there so you don't have

to deal with it

you don't have to break your head it's

there you can just select

and three zeros okay this like this you

need to write so you start with the contribution

contribution

okay for some for some items you need a

working separate working working needs

to be done separately okay

working always has to be done below your

you have to write working working number

one two three depending on how many

workings you have for contribution you

don't need any working because we are

just inflating it by eight percent and

next to it better to write inflation

also eight percent

so that you know what inflation rate you

are putting there

inflation at eight percent I'm going to

show you for one only

one only for contribution I'm going to

show you how that they have inflated it

by eight percent rest same way they have

inflated the other figure also okay then

you will know how to do it I'm not going

to show you for each item only for contribution

contribution

so contribution is eight percent they

don't it is 4.2 so with this 4.2 is it

is it that first year it is 4.2 and then

first year itself you have to inflate it

and then right now 4.2 first day and

so this itself first here itself we have

to inflate by eight percent how do you

play it by eight percent I'm showing you

here by the way okay next to this only

into 1.08 to the power 1 because for

first year okay

okay

and which figure you got is this one

sorry guys this one this is the figure

four five if you are getting a point uh

decimal something round up to the whole

uh whole figure okay whole number

four five three six

next year if you have to do it again 4.2

into 1.08 just increase the power here

to the power two then third year to the

power three fourth year to the power 4

okay but when you are doing it in Excel

it will be little different

because you need to click the previous

cell and then you need to do it or you

can just copy paste if you do it once

you can just copy paste with other cells

which will save a lot of time every year

you don't have to do this see doing it

on a CB platform is much easier this in

this things because I save a lot of time

you manually do not have to multiply

every time by 1.08 and copy paste with

other cell but that will show it later

when we do it in Excel for right now you

understand this

so every year figure will be little

little bigger than the previous

year zero nothing goes okay because in

year zero you're not earning anything

year zero is only for the inflation in

any investment that is done at the start

next inflow is done same way you have to

do it

make sure that you are getting this

figure by the way okay

until you don't get this figure don't go

to the next step you can pause the video

and then make sure you get the figure

and then go to the next that's how you

learn on your own

next is marketing okay

then is your variable cost then fixed

cost fixed cost

will be your

here the fixed costs are not given but

usually if they give fixed cost also so

variable cost is marketing expenditure

which is 1.4 same way three percent you

have template 1.4 into 1.03 to the power

one two three four five so same way you

will do it and you will get this figure

and it will be in bracket because it's

an outflow

deduct it and you will get your

operating cash flow

so operating cash flow like this

okay now we are coming to what your investment

investment

your initial investment was 7 million

okay 7 million minutes it will be 7 000

because you're dropping down the three zeros

that means you are dealing in thousands

only now okay rather than needing in

millions so 7000 this will be in year

zero just see here

initial investment will always be done

before the project Starts Now for the

first five years so years ago this is

why we need that column

then we are moving on to the

and it's an outflow again after you get

your operating cash flow only you have

to get to your initial investment that

is the

initial investment you do not put it

after marketing okay then we have asset replacement

replacement

you employed by four percent but when

you inflate it by four percent remember

this starts from if you see the column

it is starting one year behind only

starting from year 0 1 2 3 and 4 rather

than the fifth year

at the start of each year you see this

is why they have to mentioned it at the

start of each year means starting with

your zero

and here expenditure is 1.3

Forex uh replacing so 1.3 inflated by

year zero

if you see this is different from your

contribution and marketing here they

have inflated but first year they didn't

inflated they have kept it 1.3 only why

because it is here it is at year zero

dear at year 0 no inflation

at year zero no inflation 1.3 1.3 only

inflation only comes from year one so

next year you inflate third year you employed

employed

I mean this is first year second

so you're one year behind second means

third it's like that okay don't get

confused third and fourth year fifth

year no inflation because at the start

of each year

so one two three four five okay

now we are coming to the working capital

working capital is also similar you

start with year zero only because they

roll at the start of each year but

working capital if you see you are

investing it's in bracket outflow one

zero one two three four outflow but uh

last year it will be an inflow why

because we are recovering it you are

receiving it

this is this is the pattern even in your

real exam also

okay but here here there is a separate

small working number one

okay and here to find this eleven

percent discount factor is working too

but we have already done it right

right

make sure that this working that you do

for 11 percent is done under a working okay

okay

you can put it in any order working one

but I say uh the reason they have done

it is they are following their order

structure because obviously your working

capital injection will come before no

before your discount Factor that's why

they have put this as working one

they're following that chronological order

order

and Present Value working number two

okay but before going to present value

we have already done it it's over if you

see here

working number two always put a number

and you need to put appropriate heading

for it

for your workings you're getting marks

okay they have exactly used the formula

here they have put the numbers

okay then they have got I

11 percent

now working number one we are going to

working number one straight away because

from the table will not understand how

they have got that 454 36 and this one

working capital injection here also even

in working also starting with 0 1 2 3 4

5. because it's in Excel it's very easy

for you you just go down and

already it's there columns and rows

already built you don't have to earlier

days when we used to do it on a paper system

system

we have to draw take a ruler draw lines

columns sometimes one column gets missed

out or we put a number incorrectly in

another row things got really messed up

thanks to CB now much time is saved you

can just cut everything and do it again

we do it again in short span of time

anyways uh see

see

working capital was ten percent on what

on contribution

so you have already found the

contribution isn't it

that's this this this already you have

found it how go up

this other figure I'm going to highlight

it for you

these are the figure on this 10 percent

you have to apply and get it for the

contribution a working capital

because that's what they have told ten

percent on the contribution

on that you apply 10 but when you're

applying 10 you have to go one year backwards

because you are starting from your zero

working capital

if you see this is ten percent only ten

percent of four five three six is four

fifty four whole number okay

four eight nine nine so four nineteen

five two nine one five twenty nine ten

percent only this and this

this is exactly the same way you need to

do even in a real exam also so get this

straight right away okay if you have to

spend more time to do your test

understanding one do it because when you

go to the next question test your

understanding too you will be more

quicker and things will become very easy

you will see it's a repetitive thing

now how much working capital you need to inject

inject

after this is done

I'm going to use a different color maybe blue

okay see first year is very easy you're zero

see first year is very easy you're zero 454 454 but when you go to this first

454 454 but when you go to this first year

year year zero is easy first year

year zero is easy first year only how much amount is increased

only how much amount is increased sometimes it could decrease also

sometimes it could decrease also sometimes it could increase also only

sometimes it could increase also only the increase amount you need for example

the increase amount you need for example here it is 454 so from 454 to 490 how

here it is 454 so from 454 to 490 how much it increased that means only 36.

much it increased that means only 36. first year you put 454 you for the

first year you put 454 you for the second year you need to put 36. it's in

second year you need to put 36. it's in bracket because it increased when the

bracket because it increased when the amount increase it will be in bracket

amount increase it will be in bracket because more payment when it's a

because more payment when it's a decrease it's good it's an inflow that

decrease it's good it's an inflow that means without bracket so here also 490

means without bracket so here also 490 to 529 it increased 39.

only the increase amount 529 to size 7142 and 571 to 646.

529 to size 7142 and 571 to 646. every time it's increasing

in other words you can add this to NC wait

you can add this to NC 454 plus 36 will give you 490 okay this and this

give you 490 okay this and this then this 36 plus 3 uh this one sorry

then this 36 plus 3 uh this one sorry 454 plus 39

454 plus 36 plus 39 should give you 529 okay it's like a cumulative figure this

okay it's like a cumulative figure this accumulative figure

accumulative figure check out on yourself and finally at the

check out on yourself and finally at the end you have to get 617. what is 670

end you have to get 617. what is 670 this one

this one the fourth years

the fourth years this is what you have to receive

this is what you have to receive at the end

okay just give me a minute

another way to check this is what should be in the final years just

what should be in the final years just add all your these are outflows okay

add all your these are outflows okay just add all your outflows whatever

just add all your outflows whatever outflows you have got same amount you're

outflows you have got same amount you're going to recover so that means 454 plus

going to recover so that means 454 plus 36 plus 39 plus 42 plus 46 will add up

36 plus 39 plus 42 plus 46 will add up to 617. this is the ammonia will recover

to 617. this is the ammonia will recover the final year

the final year that is another way to do it or this one

that is another way to do it or this one okay

okay so now which amount you need to put in

so now which amount you need to put in the cash flow

understood working capital injection

working capital injection so this is it

so this is it 454 36 39 42 46 in bracket 617 is

454 36 39 42 46 in bracket 617 is positive without bracket bracket plays a

positive without bracket bracket plays a very important role make sure it can

very important role make sure it can make an upload to employ influent

make an upload to employ influent overflow be very careful after this

overflow be very careful after this what is the next step free cash flow

what is the next step free cash flow whatever you get is your cash flow only

whatever you get is your cash flow only don't get confused with the profit and

don't get confused with the profit and the cash flow sometimes profit figure

the cash flow sometimes profit figure might be given to you that you have to

might be given to you that you have to contribute to cash flow okay I'll just

contribute to cash flow okay I'll just convert to cash flow that also I will

convert to cash flow that also I will show you later on you cannot deal with

show you later on you cannot deal with profit here Net Present Value always

profit here Net Present Value always with cash

with cash what is it this Excel only will do some

what is it this Excel only will do some function you can do okay just deduct add

function you can do okay just deduct add influes and deduct our close that's it

so here first here first here you only have three outflows seven thousand one

have three outflows seven thousand one thousand three hundred four fifty four

thousand three hundred four fifty four that's why it's this one outflow next

that's why it's this one outflow next the first five years you'll be having an

the first five years you'll be having an inflow

inflow okay so you already have an operating

okay so you already have an operating cash flow here from this operating cash

cash flow here from this operating cash flow just deduct your or close that set

flow just deduct your or close that set your asset replacement and working

your asset replacement and working capital so one seven there's there's

capital so one seven there's there's this IR improves

this IR improves but in the final year you have to add

but in the final year you have to add the 617 with this add not deduct it's an

the 617 with this add not deduct it's an envelope

envelope that's why you see finally uh it's a

that's why you see finally uh it's a free cash flow is more than your

free cash flow is more than your previous four years

previous four years now we are coming to the discount Factor

now we are coming to the discount Factor after you got the free cash flow

after you got the free cash flow discount Factor so discount Factor also

discount Factor so discount Factor also 11 percent

11 percent first year it is one always

first year it is one always okay for this also there is a working

okay for this also there is a working 11 formula is there just use the table

11 formula is there just use the table discount Factor table and find out what

discount Factor table and find out what is the discount factor and it will be to

is the discount factor and it will be to three decimal places use the table

three decimal places use the table no need to do it manually and waste time

no need to do it manually and waste time okay

okay even when you're doing it manually also

even when you're doing it manually also in a paper based also formula table was

in a paper based also formula table was given to you therefore you could have

given to you therefore you could have used it

used it this this this

okay make sure you write these things here

make sure you write these things here make sure you write these things here so

make sure you write these things here so that when you finally find the present

that when you finally find the present cash flow rather than doing doing it in

cash flow rather than doing doing it in your head write it it becomes easier for

your head write it it becomes easier for the in Excel also for you to perform the

the in Excel also for you to perform the function

function if you have the figures in front of you

if you have the figures in front of you three decimal places if you're doing it

three decimal places if you're doing it manually let me tell you how to do it

manually let me tell you how to do it how to find this zero nine zero one

how to find this zero nine zero one it will be 1 divided by one point eleven

it will be 1 divided by one point eleven eleven to the power 1.

eleven to the power 1. for the first year second year same

for the first year second year same but to the power 2 third year one

but to the power 2 third year one divided by 1.11 11 to the power 3. it's

divided by 1.11 11 to the power 3. it's just that

okay whether you're getting it or not

but you have to round it up to the three decimal places it will be giving you a

decimal places it will be giving you a whole number big number okay you'll be

whole number big number okay you'll be getting here

getting here 0.909 something something something

0.909 something something something something so 0.901 you can use the table

something so 0.901 you can use the table or this way also it is for anything for

or this way also it is for anything for example this was 10 then it will be 1

example this was 10 then it will be 1 divided by 1.1 0 to the power one

divided by 1.1 0 to the power one everything remains same only this number

everything remains same only this number changes depending on your decimal uh the

changes depending on your decimal uh the percentage ten percent nine percent

percentage ten percent nine percent whatever

next just multiply multiply

just multiply multiply multiply free cash flow with present

multiply free cash flow with present value that's why one into eight seven

value that's why one into eight seven five four would be will be 8754 only

five four would be will be 8754 only next year only changes so multiply

next year only changes so multiply Excel can easily do it once you do it

Excel can easily do it once you do it here just copy paste to the other cell

here just copy paste to the other cell in Excel you can do this easy but

in Excel you can do this easy but manually you have to keep on multiplying

manually you have to keep on multiplying okay so this will be an inflow inflow

okay so this will be an inflow inflow inflow inflow and inflow

inflow inflow and inflow present value with the free cash flow

present value with the free cash flow you have to do this on your own and

you have to do this on your own and check get the answers get the numbers

check get the answers get the numbers okay

okay finally how do you find the present Net

finally how do you find the present Net Present Value even though financial

Present Value even though financial management students know but again

management students know but again I'm asking this question it's very easy

I'm asking this question it's very easy question I know you'll be like what is

question I know you'll be like what is this this is like basic word again

just add all add all the five with your zero that is six here that means add

zero that is six here that means add your inflows deduct your investment that

your inflows deduct your investment that is eight seven five four

is eight seven five four so your Net Present Value will be this

so your Net Present Value will be this Excel can easily do it some function

Excel can easily do it some function 790 000. okay here you are writing it

790 000. okay here you are writing it when you're right dealing it here don't

when you're right dealing it here don't just write 790.

just write 790. because you are dealing in thousands I'd

because you are dealing in thousands I'd only drop down three zeros but here you

only drop down three zeros but here you need to mention the all the three zeros

need to mention the all the three zeros the whole number you have to write so if

the whole number you have to write so if it is 798 add the three add the last

it is 798 add the three add the last three digit number zero zero zero other

three digit number zero zero zero other three zeros back again when you're

three zeros back again when you're writing the Net Present Value it is only

writing the Net Present Value it is only for that table you are dropping down the

for that table you are dropping down the three zeros once you write the Net

three zeros once you write the Net Present Value write the whole amount if

Present Value write the whole amount if it's a million write all the zeros

it's a million write all the zeros whatever it is here it is seven ninety

whatever it is here it is seven ninety thousand with the dollar sign and also

thousand with the dollar sign and also make sure whether it's a positive or A

make sure whether it's a positive or A negative figure if you are not writing

negative figure if you are not writing plus sign

plus sign still it's a positive figure but if you

still it's a positive figure but if you are putting it in bracket it means it's

are putting it in bracket it means it's a negative

a negative okay but here's plus means or if an

okay but here's plus means or if an online class also it's positive figure

online class also it's positive figure seven ninety thousand so it's good

seven ninety thousand so it's good just writing this amount is not enough

just writing this amount is not enough you need to write something else you

you need to write something else you need to write whether the project is

need to write whether the project is worthwhile or not which suggests that

worthwhile or not which suggests that the project is worthwhile

the project is worthwhile you need to mention this was worthwhile

you need to mention this was worthwhile or it's not worthwhile positive

or it's not worthwhile positive worthwhile negative not worthwhile okay

worthwhile negative not worthwhile okay this statement you need to write at the

this statement you need to write at the end okay and after this comes you're

end okay and after this comes you're working even in Excel also try to do

working even in Excel also try to do this way only

this way only working one and working will come below

working one and working will come below your answer till here is your answer

your answer till here is your answer after this working one and two so don't

after this working one and two so don't confuse don't put workings in between

confuse don't put workings in between the main table or don't start with the

the main table or don't start with the workings

workings obviously you will be leaving some space

obviously you will be leaving some space in leave some space and then do working

in leave some space and then do working one two three okay in Excel is very easy

one two three okay in Excel is very easy only we have to predict sometimes we

only we have to predict sometimes we might uh leave less space we have to

might uh leave less space we have to struggle a lot here in Excel is very

struggle a lot here in Excel is very easy

to do it okay

okay obviously you'll be working first

obviously you'll be working first because without working how will you put

because without working how will you put it but

it but when you're doing it but when you

when you're doing it but when you display it the way you present matter

display it the way you present matter solo you need to present the main table

solo you need to present the main table first

okay working one working two so that's it for

working one working two so that's it for test understanding one

test understanding one I hope this gives you a very fresh

I hope this gives you a very fresh overview of AFM and how an AFM question

overview of AFM and how an AFM question looks like and how much you have to deal

looks like and how much you have to deal with this is just nothing I mean this is

with this is just nothing I mean this is very easy when you go to the main

very easy when you go to the main question you will see

question you will see right and if it comes as a 50 marks

right and if it comes as a 50 marks question then

question then you need to deal with lots of

you need to deal with lots of information this case study is very

information this case study is very simple very nicely it has been presented

simple very nicely it has been presented to you with all the figure

to you with all the figure but in actual thing it's not that easy

but in actual thing it's not that easy also okay but don't worry

also okay but don't worry it will become easy for you I will make

it will become easy for you I will make sure it's my job to make even that one

sure it's my job to make even that one easy for you so now we are going to put

easy for you so now we are going to put taxation also and see how it looks like

taxation also and see how it looks like the effect of Taxation in in present

the effect of Taxation in in present value

impact of Taxation there are two main impacts of Taxation Indian investment

impacts of Taxation Indian investment oppressor what are they number one

oppressor what are they number one taxes charged on operating cash flows

taxes charged on operating cash flows second tax allowable depreciation okay

second tax allowable depreciation okay remember taxes never charged on the

remember taxes never charged on the profit it is always charged on the

profit it is always charged on the operating cash flows second

operating cash flows second and this definitely you will get in your

and this definitely you will get in your Net Present Value calculation definitely

Net Present Value calculation definitely there is no doubt 100 you will get it

there is no doubt 100 you will get it that is tax allowable depreciation you

that is tax allowable depreciation you always have to be prepared for it

always have to be prepared for it I have seen this in almost all the exams

I have seen this in almost all the exams sometimes it is referred to as capital

sometimes it is referred to as capital allowances or writing their allowances

allowances or writing their allowances which you get for your non-current asset

which you get for your non-current asset remember for your

remember for your motor vehicle or some non-current asset

motor vehicle or some non-current asset investment you get a first year

investment you get a first year allowance or Capital allowances and

allowance or Capital allowances and these things we have done it in tax okay

these things we have done it in tax okay and you can claim certain tax relief

and you can claim certain tax relief right for example you invest in a

right for example you invest in a non-current asset let's say in the first

non-current asset let's say in the first year or some special particular type of

year or some special particular type of non-current asset gets tax relief you

non-current asset gets tax relief you have to charge less tax

have to charge less tax right

right that is known as tax allowable

that is known as tax allowable depreciation

depreciation okay that means you can deduct this from

okay that means you can deduct this from your cash flows and your tax will reduce

your cash flows and your tax will reduce even less you will save your tax

even less you will save your tax okay

okay now

now this is the revision of tax allowable

this is the revision of tax allowable depreciation we already know this we

depreciation we already know this we have done it in financial management

have done it in financial management this is just a division of it before we

this is just a division of it before we go to our test understanding too

go to our test understanding too in the year of sale or scrap a balancing

in the year of sale or scrap a balancing allowance or charge arises

allowance or charge arises this happens when you are selling it

this happens when you are selling it right a non-current asset you are having

right a non-current asset you are having in let's say for four years at the end

in let's say for four years at the end of the project you are selling it

of the project you are selling it okay so that time of balancing allowance

okay so that time of balancing allowance or charge will arise

or charge will arise whether it's a balancing allowance or

whether it's a balancing allowance or charge difference

charge difference but the amount that you are getting is

but the amount that you are getting is negative or positive okay so first the

negative or positive okay so first the original cost of asset

original cost of asset then you deduct your cumulative tax

then you deduct your cumulative tax allowable deposition that you have

allowable deposition that you have claimed

claimed okay so you deduct your disposal value

okay so you deduct your disposal value from the written down value of the asset

and see the amount that you are getting is negative or a positive

is negative or a positive if it's a positive it's a balancing

if it's a positive it's a balancing allowance

allowance if it's a negative it's a balancing

if it's a negative it's a balancing charge

we need to do this you will understand all you will only understand this with a

all you will only understand this with a question so let us do test understanding

question so let us do test understanding two

two the impact of Taxation in your Net

the impact of Taxation in your Net Present Value earlier we have done

Present Value earlier we have done impact with inflation inflation we still

impact with inflation inflation we still will have here also but now tax is added

will have here also but now tax is added you know each step one one variables

you know each step one one variables keeps adding

keeps adding so let's do that

test your understanding too okay Net Present Value with taxation

okay Net Present Value with taxation if you compare this with your test your

if you compare this with your test your understanding one less work is required

understanding one less work is required here

here because we are only focusing on tax

because we are only focusing on tax allowable depreciation

allowable depreciation okay that is the only thing which we

okay that is the only thing which we need to work out here

need to work out here so

so just read the question and you will see

just read the question and you will see a similar nature

a similar nature to your test understanding one because

to your test understanding one because this is how your net interesting uh

this is how your net interesting uh investment approxel questions are okay

investment approxel questions are okay they will always start with the project

they will always start with the project they will give you the duration they

they will give you the duration they will give you the investment they will

will give you the investment they will give you the inflow tax rate they will

give you the inflow tax rate they will give you tax allowable depreciation rate

give you tax allowable depreciation rate they will give you cost of capital they

they will give you cost of capital they sometimes will give you sometimes you

sometimes will give you sometimes you have to work out your understanding so

have to work out your understanding so everything is given you just need to

everything is given you just need to work out the figure calculation part

work out the figure calculation part okay

okay here also is the same question Focus

here also is the same question Focus this one using Net Present Value okay so

this one using Net Present Value okay so here project requires ten thousand

here project requires ten thousand dollar initial investment and it will be

dollar initial investment and it will be disposed at the end of year 4 for 2500

disposed at the end of year 4 for 2500 that means you know it's a four year

that means you know it's a four year project

project sometimes they might not say therefore

sometimes they might not say therefore but yeah usually they say it's a four

but yeah usually they say it's a four year

year so in the year of four you're going to

so in the year of four you're going to receive this I'm going to dispose that

receive this I'm going to dispose that asset I'm going to receive 2500 sales

asset I'm going to receive 2500 sales proceed

proceed taxes payable at 30 one year a year

taxes payable at 30 one year a year remember this is very important now

remember this is very important now tax

tax can be paid in three ways either in the current year as it is same

either in the current year as it is same year this is very easy second is one

year this is very easy second is one year later like in this case third is

year later like in this case third is half this year half next year

half this year half next year okay so out of this three scenarios be

okay so out of this three scenarios be prepared for all the three scenarios so

prepared for all the three scenarios so it's nothing it's very easy

it's just the year that you are putting it matters otherwise tax the way you

it matters otherwise tax the way you calculate everything is same so here's

calculate everything is same so here's one year later okay that means the

one year later okay that means the fourth year you'll be paying in the

fourth year you'll be paying in the fifth year okay so this gives you an

fifth year okay so this gives you an idea how many columns you have to make

idea how many columns you have to make and how many years you need

and how many years you need tax allowable depreciation Tad in your

tax allowable depreciation Tad in your exam you're free to write EAD okay 25

exam you're free to write EAD okay 25 reducing balance check whether it's a

reducing balance check whether it's a reducing balance or straight line basis

reducing balance or straight line basis most of the time tax level depreciation

most of the time tax level depreciation is reducing balance they give okay but

is reducing balance they give okay but straight line is easy

straight line is easy just take 25 and same figure

just take 25 and same figure and a balancing alarm result charge

and a balancing alarm result charge should be calculated when the acid is

should be calculated when the acid is sold

sold just means just know we saw in the

just means just know we saw in the previous slide whenever cell occurs only

previous slide whenever cell occurs only this will come if Cell does not occur no

this will come if Cell does not occur no balancing allowance or chart no need to

balancing allowance or chart no need to worry about it sometimes they give you

worry about it sometimes they give you sale because sometimes they don't give

sale because sometimes they don't give yourself okay I cannot tell you 100 they

yourself okay I cannot tell you 100 they will give you

will give you if they don't give don't worry if they

if they don't give don't worry if they give balancing allowance or a charge

give balancing allowance or a charge because we don't know whether we are

because we don't know whether we are getting a positive figure or a negative

getting a positive figure or a negative figure

figure most of the time it's a balancing

most of the time it's a balancing allowance only okay 95 of the time we

allowance only okay 95 of the time we get balancing allowance that's good

get balancing allowance that's good positive

positive very rarely you might get a charge also

very rarely you might get a charge also but you need to know how to deal with

but you need to know how to deal with both if you get

net operating flow of the project are expected to be 4000 operating flow of

expected to be 4000 operating flow of the project

the project that is Cash inflow 4000 per year ignore

that is Cash inflow 4000 per year ignore inflation to make your work easy our

inflation to make your work easy our main focus is on taxable depreciation

main focus is on taxable depreciation they ignore inflation but in real exam

they ignore inflation but in real exam with inflation you will have it's

with inflation you will have it's nothing difficult

okay company's cost of capital is 10 discount Factor also you don't have to

discount Factor also you don't have to calculate it's given

how do you know it's 10 C you might be thinking how do you know

you might be thinking how do you know this is real cost of capital or nominal

this is real cost of capital or nominal cost of capital because we have already

cost of capital because we have already studied it so much from the beginning

studied it so much from the beginning because they didn't mention anything

because they didn't mention anything they just told cost of capital they

they just told cost of capital they didn't give you any inflation rate to

didn't give you any inflation rate to find out so if they don't give out any

find out so if they don't give out any missing figure you cannot use the

missing figure you cannot use the formula and find out

formula and find out and inflation is also not there so it's

and inflation is also not there so it's okay 10 percent

okay 10 percent even if inflation is there

even if inflation is there okay

okay they might they have to give you the

they might they have to give you the general rate of inflation H has to be

general rate of inflation H has to be given to you if it's not there you

given to you if it's not there you cannot find the nominal cost of capital

cannot find the nominal cost of capital then you have to take whatever the cost

then you have to take whatever the cost of capital is given to you

of capital is given to you okay so here work is very easy

okay so here work is very easy now

now if you go to the answer okay first I

if you go to the answer okay first I will take you to the table if you see

will take you to the table if you see this table this is very similar to your

this table this is very similar to your test understanding one because it will

test understanding one because it will always be

always be this is what I wanted to establish for

this is what I wanted to establish for you from the day one

you from the day one that your Net Present Value calculation

that your Net Present Value calculation is this only

is this only the stable this thing so now I think

the stable this thing so now I think you'll become very familiar with it and

you'll become very familiar with it and you can do it at a faster also try to

you can do it at a faster also try to always improve your speed

always improve your speed Maybe by one minute or two minute you

Maybe by one minute or two minute you have to finish it earlier

have to finish it earlier okay when you're working on it time

okay when you're working on it time yourself and see how long are you taking

yourself and see how long are you taking to read how long are you taking to do

to read how long are you taking to do this whole table

this whole table are you getting the correct answer is

are you getting the correct answer is accuracy maintained is neatness

accuracy maintained is neatness obviously we don't have physical

obviously we don't have physical lifestyle you are typing but

lifestyle you are typing but yeah you have to see accuracy spent and

yeah you have to see accuracy spent and speed is maintained if this two is fine

speed is maintained if this two is fine then you are on the track

then you are on the track don't wait till the final day that you

don't wait till the final day that you will be perfect now you can make

will be perfect now you can make mistakes and go ahead no

what you do from day one counsel or be consistent in it if you're if you're on

consistent in it if you're if you're on the right track be consistent if you're

the right track be consistent if you're not then you have to improve okay so

not then you have to improve okay so here again same zero one two three four

here again same zero one two three four five if you see they didn't drop down

five if you see they didn't drop down the three zeros because the figures are

the three zeros because the figures are not given in the million see sometimes

not given in the million see sometimes the figures are given to your small no

the figures are given to your small no need to drop down what are you going to

need to drop down what are you going to drop down if this amount is 40 or 50 or

drop down if this amount is 40 or 50 or 4000 or 1000 no need only if the figures

4000 or 1000 no need only if the figures are given in millions or billions then

are given in millions or billions then it makes sense to you drop down the

it makes sense to you drop down the three zeros

three zeros billions obviously they will not go to

billions obviously they will not go to billions million is the max okay so here

billions million is the max okay so here everything is in thousands so no need no

everything is in thousands so no need no need to drop down to three zeros because

need to drop down to three zeros because if you drop down the three zeros then

if you drop down the three zeros then you'll be dealing with let's say four

you'll be dealing with let's say four three point nine one point five it

three point nine one point five it becomes very uh

becomes very uh you know

you know it does not even look professional

it does not even look professional so four thousand

so four thousand so net inflow they told ignore inflation

so net inflow they told ignore inflation so four thousand four thousand four

so four thousand four thousand four thousand four thousand starting from

thousand four thousand starting from year one okay one two three four don't

year one okay one two three four don't put it in year five why did we add this

put it in year five why did we add this year 5 because the project is only for

year 5 because the project is only for the four years why because of tax only

the four years why because of tax only because taxes paid one year later only

because taxes paid one year later only for that reason understand okay

for that reason understand okay I will maybe I will mention it also so

I will maybe I will mention it also so that you know tax

that you know tax only for that otherwise nothing you are

only for that otherwise nothing you are going to do with that uh year five

going to do with that uh year five you're not going to touch it also

you're not going to touch it also everything from one to four

everything from one to four now

now this are trading inflows

this are trading inflows now

now what do you need to do with it

what do you need to do with it caching flow

caching flow deduct

deduct remember

remember when you are finding tax okay first you

when you are finding tax okay first you need to find tax on

need to find tax on you need to find taxable profit

why you are getting a tax relief because of

you are getting a tax relief because of this tax allowable depreciation

this tax allowable depreciation okay

okay now you will understand why we add and

now you will understand why we add and why we deduct okay we first deduct tax

why we deduct okay we first deduct tax allowable depreciation

allowable depreciation then we add it back also if you see here

then we add it back also if you see here same figure only but you need to find

same figure only but you need to find out how we got the figure for the first

out how we got the figure for the first four years

just just wait a minute uh I think this is not caching flow this 4000 has uh net

is not caching flow this 4000 has uh net operating flows from the project four

operating flows from the project four thousand per year

okay okay it's an inflow itself okay

okay anyways first we will go to the working

anyways first we will go to the working okay no need to write one two three

okay no need to write one two three there's only one working and label your

there's only one working and label your working tax allowable depreciation now

working tax allowable depreciation now you're starting with the cost of the

you're starting with the cost of the capital the cost of the capital is your

capital the cost of the capital is your initial investment

initial investment that ten thousand

that ten thousand it's it's 25 percent reducing balance so

it's it's 25 percent reducing balance so we know reducing balance every year you

we know reducing balance every year you add till you reach to for four fourth

add till you reach to for four fourth year you're selling in the third year

year you're selling in the third year fourth year you are going to get a

fourth year you are going to get a balancing alarm without charge

balancing alarm without charge okay so 25 of 10 000 is 2500 deducted

okay so 25 of 10 000 is 2500 deducted then you are getting a written down

then you are getting a written down value from there again deduct 25 percent

value from there again deduct 25 percent third year again deduct like this three

third year again deduct like this three times you have to deduct one two three

times you have to deduct one two three and when you're coming in the fourth

and when you're coming in the fourth year you are not deducting 25 percent

year you are not deducting 25 percent what are you doing

what are you doing what are you doing

what are you doing sale proceed of 2500 this is how much

sale proceed of 2500 this is how much you are going to get this proceed in the

you are going to get this proceed in the fourth year deduct it from your written

fourth year deduct it from your written down value if you see your sale proceed

down value if you see your sale proceed okay it's a less than your written down

okay it's a less than your written down value

value you are going to get a balancing

you are going to get a balancing announcement because this is a positive

announcement because this is a positive figure balancing allowance it's a

figure balancing allowance it's a balancing allowance

balancing allowance okay

okay so when you are writing for the first

so when you are writing for the first three years it's easy why because first

three years it's easy why because first year 2500 second year one is seven five

year 2500 second year one is seven five third year one four zero six but the

third year one four zero six but the fourth year balancing allowance is what

fourth year balancing allowance is what you are writing one seven one nine you

you are writing one seven one nine you see

see one seven one nine

one seven one nine this is what first three is easy

this is what first three is easy for the only you need a balancing

for the only you need a balancing allowance that's why you need to find

allowance that's why you need to find that that balancing allowance

that that balancing allowance to put it in the table of tax allowable

to put it in the table of tax allowable depreciation and the same thing only you

depreciation and the same thing only you are adding back

see here you are deducting I will tell you because you want to find taxable

you because you want to find taxable profit

you first need to find taxable profit this only happens with tax when tax is

this only happens with tax when tax is involved

involved you first take taxable profit because

you first take taxable profit because you uh on profit your charge tax

you uh on profit your charge tax before you convert to cash flow you

before you convert to cash flow you first need to charge tax

first need to charge tax where on profit you already know the tax

where on profit you already know the tax but you first need to have that profit

but you first need to have that profit otherwise how are you going to charge

otherwise how are you going to charge tax on what

tax on what I think earlier I told you to ask tax on

I think earlier I told you to ask tax on cash no you charge tax on profit then

cash no you charge tax on profit then you convert to cash

you convert to cash so first find taxable profit how are you

so first find taxable profit how are you going to find taxable profit inflow is

going to find taxable profit inflow is there cash inflow is there just deduct

there cash inflow is there just deduct your tax allowable depreciation

your tax allowable depreciation deduct this is this this is the step

tax allowable depreciation from inflows

then you will get your taxable profit after you get your taxable profit tax is

after you get your taxable profit tax is 30 percent

30 percent tax payable deduct that tax on the

tax payable deduct that tax on the profit

okay you need to deduct that tax on profit but they told one year later so

profit but they told one year later so year one will be year two year two will

year one will be year two year two will be three three will be for four will be

be three three will be for four will be five

five four years only but it will be paid one

four years only but it will be paid one year later

okay I think tax working is not done now just 30 percent you have to find out

now just 30 percent you have to find out so thirty percent of what

thirty percent of 1500 you have to find tax

tax on the taxable profit on this you have

on the taxable profit on this you have to find thirty percent which will be 450

to find thirty percent which will be 450 30 on two one two five six thirty eight

30 on two one two five six thirty eight thirty percent on two five nine four

thirty percent on two five nine four this then thirty percent of this amount

this then thirty percent of this amount is this

is this that's why you need to find taxable

that's why you need to find taxable profit to find that tax payable

okay once you get it the job of tax level deposition is over

the job of tax level deposition is over it is only for you to find the tax again

it is only for you to find the tax again now normally add back tax allowable

now normally add back tax allowable deposition add back

deposition add back the same year you have deducted it same

the same year you have deducted it same year you will add back also same amount

okay you need to add back after you've finished your tax then only you you

finished your tax then only you you deducted this tax level depreciation

deducted this tax level depreciation only to find the taxes that's it

only to find the taxes that's it otherwise there is no no use for you to

otherwise there is no no use for you to find the taxable profit the older uses

find the taxable profit the older uses for you to find the tax that's it that's

for you to find the tax that's it that's why this additional steps you have to do

why this additional steps you have to do otherwise you initially we could just

otherwise you initially we could just take it from the cache and discount it

take it from the cache and discount it but you cannot do it you need tax right

so you deduct first from your inflow that is four thousand find the taxable

that is four thousand find the taxable profit on that charge tax and then add

profit on that charge tax and then add back again job is job of tax level

back again job is job of tax level deposition is over at work again okay

deposition is over at work again okay then normal way you can proceed

then normal way you can proceed initial investment ten thousand

initial investment ten thousand write a non-current asset take it in

write a non-current asset take it in year zero you're always in year zero and

year zero you're always in year zero and what is your sale process four thousand

what is your sale process four thousand this is you are receiving in the fourth

this is you are receiving in the fourth year

year make sure it's in the column

make sure it's in the column 2500 you are receiving so I'll proceed

2500 you are receiving so I'll proceed it's an inflow now normally

it's an inflow now normally free cash flow

free cash flow right

right I know you I think you know the plus

I know you I think you know the plus minus so yeah I don't have to worry

minus so yeah I don't have to worry about it first is ten thousand only

about it first is ten thousand only second year

second year how do you do second year I have to show

how do you do second year I have to show you the sorry the first here I have to

you the sorry the first here I have to show you the first year

see whatever taxable profit you got add back

whatever taxable profit you got add back so 1500 plus 2500 is four thousand same

so 1500 plus 2500 is four thousand same way here taxable profit deduct tax add

way here taxable profit deduct tax add taxable allowable depreciation

taxable allowable depreciation okay

maybe you can memorize these things first you deduct find taxable profit

first you deduct find taxable profit deduct tax and add back so this steps

deduct tax and add back so this steps you memorize it and keep it and same you

you memorize it and keep it and same you can apply for the other questions also

can apply for the other questions also okay this will help you

discount factor is 10 so just take the discount factor from the table multiply

discount factor from the table multiply this two column this free cash flow and

this two column this free cash flow and discount Factor just multiply and you

discount Factor just multiply and you will get this figure

will get this figure if you see this present value will be

if you see this present value will be lesser than your free cash flow smaller

lesser than your free cash flow smaller because you're multiplying by discount

because you're multiplying by discount factor which is smaller than one that's

factor which is smaller than one that's why you will get less amount understand

why you will get less amount understand present value will be less than this one

present value will be less than this one so

so take the sum or sum of all this

take the sum or sum of all this this is your Net Present Value which is

this is your Net Present Value which is positive two five seven six so it's

positive two five seven six so it's worthwhile to go ahead with the project

worthwhile to go ahead with the project now Net Present Value is over we are

now Net Present Value is over we are moving on to the next method of

moving on to the next method of appraising an investment that is irr

appraising an investment that is irr internal rate of rate

the second method of oppressing an investment

oppressing an investment irr has a fallen feature

irr has a fallen feature it represents the discount rate at which

it represents the discount rate at which net present value of investment is zero

second you don't have to memorize this formula because you just need to find

formula because you just need to find out how you need to calculate irr number

out how you need to calculate irr number one number two you just need to uh

one number two you just need to uh compare this with your Net Present Value

compare this with your Net Present Value that's the only two things you need to

that's the only two things you need to do because questions on irr is very

do because questions on irr is very smart come on maybe four five six marks

smart come on maybe four five six marks okay

okay so it can be found by linear inter uh

so it can be found by linear inter uh interpolation what is this linear

interpolation what is this linear interpolation we'll see now

interpolation we'll see now in the next slide

in the next slide standard projects what are standard

standard projects what are standard projects normally first we have an

projects normally first we have an outflow we invest and then we start

outflow we invest and then we start getting inflows

getting inflows and it's inflows for all the years

and it's inflows for all the years right

right in that case that is known as standard

in that case that is known as standard projects normally all the projects are

projects normally all the projects are like that so in this kind of projects

like that so in this kind of projects irr

irr should be uh the project should be

should be uh the project should be accepted if irr is greater than the cost

accepted if irr is greater than the cost of capital

of capital correct but some projects are not

correct but some projects are not standard their irr could be an issue

standard their irr could be an issue okay that comes as a disadvantage of irr

okay that comes as a disadvantage of irr the steps in linear interpolation are

the steps in linear interpolation are first you need to calculate net present

first you need to calculate net present value

value for the two project at different two

for the two project at different two different cost of capital too only not

different cost of capital too only not not one not three two

not one not three two okay

so this is the first step second

second use following formula to find Irish

use following formula to find Irish so this is the formula formula is given

so this is the formula formula is given to you in your formula sheet also but I

to you in your formula sheet also but I always say

always say you're not trying to find out the

you're not trying to find out the formula J then going through it waste a

formula J then going through it waste a lot of time if you know the formula

lot of time if you know the formula Things become very easy just apply it

Things become very easy just apply it you don't have to write the formula in

you don't have to write the formula in the exam your Excel no just

the exam your Excel no just when you do the working in the Excel

when you do the working in the Excel sheet okay when the examiner clicks you

sheet okay when the examiner clicks you are working the cell they they can see

are working the cell they they can see the working so you don't have to write

the working so you don't have to write irr equals to L plus this things is not

irr equals to L plus this things is not needed

needed don't waste your time writing all this

don't waste your time writing all this for me you just need to work out the

for me you just need to work out the number put in different cell and then do

number put in different cell and then do a working in one cell and show the irr

a working in one cell and show the irr as this much

as this much I will show you in a CV platform maybe

I will show you in a CV platform maybe you will understand it much better

you will understand it much better l

l stands for lower rate of interest H

stands for lower rate of interest H stands for higher rate of interest NL is

stands for higher rate of interest NL is for Net Present Value at lower rate of

for Net Present Value at lower rate of interest NH at higher rate of interest

interest NH at higher rate of interest Net Present Value so this with a

Net Present Value so this with a calculation only you will understand

calculation only you will understand right without a calculation you will not

right without a calculation you will not understand this uh

understand this uh by error how we use interpolation rate

by error how we use interpolation rate but know this

but know this okay

okay so first if you see in the numerator l l

so first if you see in the numerator l l is the higher lower rate of interest

is the higher lower rate of interest plus always the lower rate of interest

plus always the lower rate of interest plus okay L plus NL

plus okay L plus NL Net Present Value okay so in the middle

Net Present Value okay so in the middle portion

portion in the fraction remember the fraction

in the fraction remember the fraction only deals with Net Present Value if you

only deals with Net Present Value if you need to memorize I'm telling you how you

need to memorize I'm telling you how you memorize you start with the lower rate

memorize you start with the lower rate of interest

of interest middle portion you add

middle portion you add the fraction only with the Net Present

the fraction only with the Net Present Value you don't have to deal with

Value you don't have to deal with interest rate

interest rate top again lower rate of Internet present

top again lower rate of Internet present value with lower rate of interest NL

value with lower rate of interest NL divide by

divide by NL minus NH

NL minus NH okay 100 minus a n h

okay 100 minus a n h you might be thinking you are getting a

you might be thinking you are getting a negative trigger right

negative trigger right see negative and positive does not

see negative and positive does not matter here so much okay we just need to

matter here so much okay we just need to know the difference that's it between

know the difference that's it between Net Present Value the low rate of

Net Present Value the low rate of interest versus Net Present Value the

interest versus Net Present Value the higher rate of interest okay

higher rate of interest okay because you are taking NL at the top

because you are taking NL at the top start with the NL at the bottom also and

start with the NL at the bottom also and NL minus NH

NL minus NH into

into after that again you are dealing with

after that again you are dealing with the interest rate H minus L higher rate

the interest rate H minus L higher rate of interest minus lower rate of interest

of interest minus lower rate of interest the difference only we want to know

the difference only we want to know let's say high rate of interest is 10

let's say high rate of interest is 10 lower rate of interest is five percent

lower rate of interest is five percent so 10 minus 5 is 5.

so 10 minus 5 is 5. okay

okay now let us go to test understanding

now let us go to test understanding three to understand irr better before we

three to understand irr better before we move on to a third way of dealing with

move on to a third way of dealing with investment appraisal that's a new way in

investment appraisal that's a new way in AFM it's not the in financial management

AFM it's not the in financial management that is m i r r

that is m i r r modified internal rate of return

modified internal rate of return internal rate of return has been

internal rate of return has been modified because irr has some

modified because irr has some limitations

limitations we'll see later what are those

we'll see later what are those limitations

test understanding three same way how we have a formula in Excel for a Net

have a formula in Excel for a Net Present Value we have for irr also this

Present Value we have for irr also this I am going to show you when we do a

I am going to show you when we do a question on irr on spreadsheet

question on irr on spreadsheet so

so an initial investment of 2000

an initial investment of 2000 yields cash inflow of 500 500 600 600

yields cash inflow of 500 500 600 600 and 450 at 12 months interval okay every

and 450 at 12 months interval okay every year so they have given you for the

year so they have given you for the uh one two three four five years there

uh one two three four five years there is no scrap value funds are available to

is no scrap value funds are available to finance a project at 12 percent

finance a project at 12 percent now you have to use both Net Present

now you have to use both Net Present Value and irr to decide whether the

Value and irr to decide whether the project is worthwhile or not

project is worthwhile or not okay but in the exam they will not give

okay but in the exam they will not give you like this they will not give you

you like this they will not give you both the methods

like not a full-fledged but yeah some parts

but first we are going to start with you always need to start with Net Present

always need to start with Net Present Value if you have a doubt whether to

Value if you have a doubt whether to start with irr or Net Present Value you

start with irr or Net Present Value you need to start with Net Present Value why

need to start with Net Present Value why you need to Net Present Value

you need to Net Present Value one you will get it after you do this

one you will get it after you do this calculation the other one is you have to

calculation the other one is you have to estimate because irr works on trial and

estimate because irr works on trial and error okay

error okay but that does not mean that hundred

but that does not mean that hundred times you have to try I will give you a

times you have to try I will give you a shortcut to know how to decide on your

shortcut to know how to decide on your net

net next irr I mean next

next irr I mean next rate

rate okay discount rate so when you are going

okay discount rate so when you are going with a Net Present Value approach

with a Net Present Value approach normally list all your this is an

normally list all your this is an outflow that's my negative rest all our

outflow that's my negative rest all our inflow just take 12 percent and discount

inflow just take 12 percent and discount it and present value is negative 98 so

it and present value is negative 98 so you tell me is it worthwhile no project

you tell me is it worthwhile no project should be rejected because you are

should be rejected because you are getting a negative 100 value I'm not

getting a negative 100 value I'm not going to go to calculation one by one

going to go to calculation one by one because we are more focused on the irr

because we are more focused on the irr now so irr I'm going to take you through

now so irr I'm going to take you through okay

okay so we know that at 12 percent irr sorry

so we know that at 12 percent irr sorry your net present value is negative now

your net present value is negative now we already know one Net Present Value we

we already know one Net Present Value we have one discount rate we have

have one discount rate we have interest rate we have what do we want we

interest rate we have what do we want we want another interest rate and another

want another interest rate and another Net Present Value

Net Present Value okay

okay but to find Net Present Value we need

but to find Net Present Value we need another discount you do not decide on

another discount you do not decide on Net Present Value you have to calculate

Net Present Value you have to calculate it you can only decide on your interest

it you can only decide on your interest rate

rate that is the only thing you can decide

that is the only thing you can decide now you have to be uh smart enough to

now you have to be uh smart enough to tell me okay whether the rate should be

tell me okay whether the rate should be more than 12 or less than 12 percent

more than 12 or less than 12 percent what do you think

it should be should be less than

should be less than less than 12 percent

next discount rate should be less than 12 why because with 12 if you are

12 why because with 12 if you are getting a negative having a lesser

getting a negative having a lesser discount rate

discount rate let's say eight percent

let's say eight percent or ten percent also you will have a

or ten percent also you will have a higher net present value or maybe one

higher net present value or maybe one positive even if not negative but higher

positive even if not negative but higher than this minus 98 you could have a

than this minus 98 you could have a positive Net Present Value that's what

positive Net Present Value that's what we want

we want one Higher Net Present Value one low Net

one Higher Net Present Value one low Net Present Value it need not be exactly

Present Value it need not be exactly positive

positive Net Present Value

Net Present Value sometimes you might get Negative there

sometimes you might get Negative there also but at least that amount will be

also but at least that amount will be higher than this amount

higher than this amount okay see you when we are doing irr when

okay see you when we are doing irr when you are having a negative Net Present

you are having a negative Net Present Value with one discount rate our next

Value with one discount rate our next objective should be to final interest

objective should be to final interest rate which will have a positive Net

rate which will have a positive Net Present Value even if not positive

Present Value even if not positive positive higher than this

okay negative positive so that's why it should be less

should be less lesser the interest rate higher The Net

lesser the interest rate higher The Net Present Value that's how it works write

Present Value that's how it works write it somewhere

it somewhere lesser

lesser the interest

higher or you can say not always positive but yes higher Net Present

positive but yes higher Net Present Value

Value this is what we want remember the

this is what we want remember the formula

formula Net Present Value at higher end Net

Net Present Value at higher end Net Present Value lower it that's why it

Present Value lower it that's why it cannot go be same

cannot go be same even if you take 11 percent with eleven

even if you take 11 percent with eleven percent also you can work this

percent also you can work this calculation It's just sometimes you

calculation It's just sometimes you might be wondering how do I get eight

might be wondering how do I get eight percent how do I predict see anything

percent how do I predict see anything less than 12 percent will work just put

less than 12 percent will work just put any number randomly interpolation rate

any number randomly interpolation rate will work it out for you you don't have

will work it out for you you don't have to worry even if it's eleven percent you

to worry even if it's eleven percent you might be getting still a negative Net

might be getting still a negative Net Present Value does not matter still you

Present Value does not matter still you can go ahead with this that's the beauty

can go ahead with this that's the beauty of the formula you might get something

of the formula you might get something minus 49 let's say for example still you

minus 49 let's say for example still you can work it out

can work it out but it should be less than 12 percent

but it should be less than 12 percent if it's more than 12 what happens if

if it's more than 12 what happens if you're taking 15 for example you will

you're taking 15 for example you will get even lower than this it will be even

get even lower than this it will be even higher uh Net Present Value I mean lower

higher uh Net Present Value I mean lower in terms of amount yes but it's a

in terms of amount yes but it's a negative let's say 114.

negative let's say 114. which you don't want

which you don't want you want to avoid it

but if it's the other way around let's say this is plus 98 what do you want you

say this is plus 98 what do you want you want a number lower than this if it's

want a number lower than this if it's plus you want a number in negative so

plus you want a number in negative so basically we're looking for different

basically we're looking for different signs with one Net Present Value you

signs with one Net Present Value you want a positive sign with other Net

want a positive sign with other Net Present Value you want a negative sign

Present Value you want a negative sign that's what you want

that's what you want and basically we are finding the

and basically we are finding the distance between these two why because

distance between these two why because our interest is what to find an interest

our interest is what to find an interest rate which gives you zero Net Present

rate which gives you zero Net Present Value

Value which gives you Net Present Value equals

which gives you Net Present Value equals to zero that's what we want

to zero that's what we want so one number could be higher than zero

so one number could be higher than zero which is positive one number could be

which is positive one number could be less than zero which is negative we want

less than zero which is negative we want to find the distance between these two

to find the distance between these two and we want to find this interest rate

and we want to find this interest rate which gives you net present value of

which gives you net present value of zero that's what we want that's why we

zero that's what we want that's why we are doing this interpolation but you

are doing this interpolation but you don't need to understand all this why we

don't need to understand all this why we are doing interpolation and all these

are doing interpolation and all these things

things just know the method

if it's plus 98 in that case you need a number if if it's a plus for example

number if if it's a plus for example your first interest rate or discount

your first interest rate or discount rate is giving you a positive figure

rate is giving you a positive figure positive Net Present Value you want a

positive Net Present Value you want a next Net Present sorry next discount

next Net Present sorry next discount rate which will give you a lower amount

rate which will give you a lower amount that that means your discount rate

that that means your discount rate should be higher than 12 percent but in

should be higher than 12 percent but in this case it's negative so you want

this case it's negative so you want lower than 12 percent

lower than 12 percent okay so that's why you see next one is

okay so that's why you see next one is eight percent

eight percent you can read the explanation also

you can read the explanation also since net percent value negative zero we

since net percent value negative zero we must decrease the discount rate to bring

must decrease the discount rate to bring the net present value towards zero

the net present value towards zero towards 0 you want to bring that means

towards 0 you want to bring that means towards positive if not positive also at

towards positive if not positive also at least towards zero so towards zero only

least towards zero so towards zero only reducing it

reducing it that means lower than minus 98. so here

that means lower than minus 98. so here this already is there

this already is there we need to work out 88 discounted and

we need to work out 88 discounted and you will get Plus 108.

you will get Plus 108. here it's positive even if it does not

here it's positive even if it does not positive it should be less than this

positive it should be less than this figure because you want to bring it

figure because you want to bring it towards zero okay

towards zero okay now

irr is what is it eight percent is it 12 no irr is in between these two that's

no irr is in between these two that's why we do interpolation

why we do interpolation okay so interpolation method is this

okay so interpolation method is this 108.

108. why because you start with

why because you start with you start with see you start with eight

you start with see you start with eight percent because eight percent is lower

percent because eight percent is lower interest rate I told you lower plus this

interest rate I told you lower plus this fraction only deals with Net Present

fraction only deals with Net Present Value so lower Net Present Value

Value so lower Net Present Value is what

is what it's not 98 it's 108 shocking how

it's not 98 it's 108 shocking how because at eight percent you are having

because at eight percent you are having this whatever the interest rate you are

this whatever the interest rate you are having the Net Present Value that you

having the Net Present Value that you have to write at eight percent you're

have to write at eight percent you're having 108. The Net Present Value at

having 108. The Net Present Value at lower interest rate so that means Net

lower interest rate so that means Net Present Value at eight percent that's

Present Value at eight percent that's why 180 is at the top whatever you put

why 180 is at the top whatever you put at the top

at the top below also you start with that number

below also you start with that number only at least understand this much it

only at least understand this much it will become very easy for you 108 minus

will become very easy for you 108 minus you have to deduct always deduct minus

you have to deduct always deduct minus minus 98 because it's a negative figure

minus 98 because it's a negative figure so minus minus will become Plus

so minus minus will become Plus try to work out on your own

try to work out on your own try to do this on Excel your Excel even

try to do this on Excel your Excel even if you're not doing it on a CB platform

if you're not doing it on a CB platform your normal Excel that you have

your normal Excel that you have try to do it on your calculator also

try to do it on your calculator also okay do it both the way and check are

okay do it both the way and check are you getting the same one so if you're

you getting the same one so if you're getting the same answer a loss that's

getting the same answer a loss that's that's fine

that's fine into

into higher interest rate minus lower

higher interest rate minus lower interest rate always higher interest

interest rate always higher interest rate minus low interest rate it should

rate minus low interest rate it should be positive it should not give a

be positive it should not give a negative figure that's why High minus

negative figure that's why High minus low

low but you start with low okay 12 minus 884

but you start with low okay 12 minus 884 volts

volts so can we deal with this okay eight

so can we deal with this okay eight percent plus what will the fraction give

percent plus what will the fraction give you

Plus sorry into 12 minus 8 is 4 percent

sorry into 12 minus 8 is 4 percent so this is eight percent plus 0.52 into

so this is eight percent plus 0.52 into four percent now tell me first you add

four percent now tell me first you add or first you multiply

first you add a first you multiply you have to be good in your math a

you have to be good in your math a little bit at least

little bit at least multiply first and then you add eight

multiply first and then you add eight percent

percent what Mass applies everywhere what must

what Mass applies everywhere what must you know what was

you know what was division multiplication over addition

division multiplication over addition and subtraction

and subtraction so first you multiply

so first you multiply 0.524 into four percent that's a 0.04

0.524 into four percent that's a 0.04 plus this with eight

one way to deal with decimals okay convert everything to decimal eight and

convert everything to decimal eight and four percent

four percent this I usually don't go by that method I

this I usually don't go by that method I say go by percentage just put the whole

say go by percentage just put the whole number in your calculator 4 as it is

number in your calculator 4 as it is don't put percentage percentage you only

don't put percentage percentage you only write but when you're doing it in the

write but when you're doing it in the calculation just multiply by four zero

calculation just multiply by four zero point five two into four plus eight

point five two into four plus eight we'll see how it is

it will be same same amount only

same same amount only 10.0

10.0 96 this is 0.1096 this is 10.096 is the

96 this is 0.1096 this is 10.096 is the same but just don't take percentage in

same but just don't take percentage in the calculator so it's up to you

the calculator so it's up to you 10.096 means 10.1 percent only

10.096 means 10.1 percent only so it's correct

so it's correct okay both the method Excel also you have

okay both the method Excel also you have to do manually also you have to do first

to do manually also you have to do first do it manually then do it in the Excel

do it manually then do it in the Excel now tell me project should be accepted

now tell me project should be accepted or not Net Present Value says reject

or not Net Present Value says reject because negative irr also says reject

because negative irr also says reject why

why because 10.1 percent is less than 12

because 10.1 percent is less than 12 percent irr is less than your cost of

percent irr is less than your cost of capital cost of capital is not 88 it is

capital cost of capital is not 88 it is your original discount rate that is 12

your original discount rate that is 12 percent borrowing your cost of borrowing

percent borrowing your cost of borrowing you have to compare it with your cost of

you have to compare it with your cost of borrowing irr

borrowing irr this is 12 percent that eight percent we

this is 12 percent that eight percent we only use for interpolation to find irr

only use for interpolation to find irr okay rest all you are comparing it with

okay rest all you are comparing it with twelve percent only

twelve percent only so in under both the method you reject

so in under both the method you reject see this becomes easier because

see this becomes easier because it has an outflow first

it has an outflow first then it has inflow inflow inflow inflow

then it has inflow inflow inflow inflow envelope normal standard Cash Flow but

envelope normal standard Cash Flow but what if sometimes you are getting

what if sometimes you are getting positive again negative again positive

positive again negative again positive will irr give you a similar uh

will irr give you a similar uh answer to a net wasn't value here it's

answer to a net wasn't value here it's easy because under both you reject but

easy because under both you reject but what if Net Present values is reject and

what if Net Present values is reject and irr says except or the other way wrong

irr says except or the other way wrong it can happen right it it can happen

it can happen right it it can happen that's why we have we need to modify

that's why we have we need to modify this irr and the term is known as

this irr and the term is known as modified internal rate of return m i r r

modified internal rate of return m i r r the next which we are going to discover

the next which we are going to discover now so let's go through that

as I mentioned that irr was having some problems that's why we need to come up

problems that's why we need to come up to the next best solution that is mirror

to the next best solution that is mirror what are the problems

what are the problems you need to know these problems because

you need to know these problems because you need to write this sometimes in the

you need to write this sometimes in the exam when you have to compare irr with

exam when you have to compare irr with other methods okay

other methods okay so one is the Assumption issue it

so one is the Assumption issue it assumes that irrs assume to be measured

assumes that irrs assume to be measured at the rate of

at the rate of uh is assumed to be measure of the rate

uh is assumed to be measure of the rate from a project which is not

from a project which is not okay it's a measure of the return from

okay it's a measure of the return from the project sorry

the project sorry that if you get irr that's how much you

that if you get irr that's how much you are returning from the Project based on

are returning from the Project based on the percentage of irr which is not it's

the percentage of irr which is not it's just an assumption

just an assumption okay

okay irr assumes

irr assumes that the project can be reinvested at

that the project can be reinvested at irr

that is the rate of the irr is the rate of the return also from the project

of the return also from the project that's it that's an assumption which is

that's it that's an assumption which is not correct

not correct okay

second the decision rule whether you have to go

the decision rule whether you have to go with the project or not based on irr is

with the project or not based on irr is not very clear for positive for Net

not very clear for positive for Net Present Value is easy positive you go

Present Value is easy positive you go negative Net Present Value you don't go

negative Net Present Value you don't go why because positive net present value

why because positive net present value means it maximizes your shareholder

means it maximizes your shareholder wealth that is a fundamental objective

wealth that is a fundamental objective of financial management but not for irr

of financial management but not for irr is not like that

is not like that because some projects can have two irr

because some projects can have two irr also

also then how do you say which one to take

usually we say accept the project which gives the higher irr higher than the

gives the higher irr higher than the cost of capital but if there are two irr

cost of capital but if there are two irr then how do you say one project only is

then how do you say one project only is having two irr

having two irr it's very difficult

it's very difficult this happens when your uh cash flow

this happens when your uh cash flow changes you are having an imploma in

changes you are having an imploma in flow or flow like that not a standard

flow or flow like that not a standard project third choosing between projects

when they are having multiple irr or even none at all it's difficult to

even none at all it's difficult to usually compare projects using irr you

usually compare projects using irr you cannot say a project having 13 irr is

cannot say a project having 13 irr is better than a project having 14 irr

better than a project having 14 irr it's difficult to compare

so therefore the superior method see in the examples

the superior method see in the examples when you have to write okay you can

when you have to write okay you can write this as an answer Superior method

write this as an answer Superior method for investment application is always

for investment application is always netters in value over irr

netters in value over irr because Net Present Value is more

because Net Present Value is more reliable than irr also

reliable than irr also okay

okay next

next even better than irr is mirror

even better than irr is mirror because we have seen issues with irr

because we have seen issues with irr what is it

what is it cash flow problems nmi but mirror solves

cash flow problems nmi but mirror solves those issues which irr was having

okay it's Unique second it gives a measure of the return

second it gives a measure of the return from a project

third is a simple percentage mirror is unique

unique not having Mir does not have multiple

not having Mir does not have multiple Mir or only one mirror so it's Unique

Mir or only one mirror so it's Unique and it gives a measure of the return of

and it gives a measure of the return of the project also third

the project also third only one percent a simple percentage

only one percent a simple percentage so it's easy to understand also because

so it's easy to understand also because it's just a percentage everyone

it's just a percentage everyone understands percentage

understands percentage okay so even non-financial managers will

okay so even non-financial managers will understand this if you say Mir is thirty

understand this if you say Mir is thirty percent twenty percent

okay so mirror is equals to projects written but this is not true for irr irr

written but this is not true for irr irr so if Project Return is greater than

so if Project Return is greater than your cost of finance that means mirrr is

your cost of finance that means mirrr is greater than company's cost of Finance

greater than company's cost of Finance cost of capital except the project

cost of capital except the project otherwise reject

otherwise reject the interpretation of uh interpretation

the interpretation of uh interpretation of IMR how do you interpret

it measures the economic kill of investment under the assumption

investment under the assumption assumption is different here and it is

assumption is different here and it is more aligned with Net Present Value

more aligned with Net Present Value assumption is that any cash surpluses

assumption is that any cash surpluses are reinvested at the company's cost of

are reinvested at the company's cost of capital

okay then although mirror like mirrr cannot

then although mirror like mirrr cannot replace netters and values the principal

replace netters and values the principal Evolution what is the principal

Evolution what is the principal evaluation technique for investment

evaluation technique for investment oppressor will always be Net Present

oppressor will always be Net Present Value only mirrr cannot replace that but

Value only mirrr cannot replace that but it is better than irr somewhere in

it is better than irr somewhere in between irr and a Net Present Value you

between irr and a Net Present Value you can say

can say okay even though it cannot replace but

okay even though it cannot replace but it does give a measure of the maximum

it does give a measure of the maximum cost of finance that firm could sustain

these are some advantages you can write for Mirror okay for this reason it gives

for Mirror okay for this reason it gives a useful insight into the margin of

a useful insight into the margin of error or room for negotiation

error or room for negotiation when something is in between it's easy

when something is in between it's easy for you to negotiate and it is between

for you to negotiate and it is between two things not in two extremes they saw

two things not in two extremes they saw that

that so some margin of error is there is if

so some margin of error is there is if it's there mirror is useful in that case

it's there mirror is useful in that case okay

okay then calculation of mirror this is the

then calculation of mirror this is the formula

formula formulas there in your formula sheet

formulas there in your formula sheet even in your CV platform you can open it

even in your CV platform you can open it and check

and check okay

okay but I always used to memorize memorize

but I always used to memorize memorize in a sense of not PVR divided by PV and

in a sense of not PVR divided by PV and into the power one and not like that I

into the power one and not like that I used to do questions questions and then

used to do questions questions and then I used to the more questions you do on

I used to the more questions you do on mirror you know

mirror you know automatically the formula is there

so that's how I learned I used to learn formulas never used to memorize like

formulas never used to memorize like this only

this only without doing questions it will not help

without doing questions it will not help but let me tell you

but let me tell you what it stands for PVR present value of

what it stands for PVR present value of return phase of the project return phase

return phase of the project return phase means only cash inflow you do not touch

means only cash inflow you do not touch the outflow next PBI that is in the

the outflow next PBI that is in the denominator present value of the

denominator present value of the investment phase that is your initial

investment phase that is your initial investment only

investment only you find the present value of that but

you find the present value of that but normally is the same only because in

normally is the same only because in year 0 so no present value okay R is the

year 0 so no present value okay R is the firm's cost of capital all these three

firm's cost of capital all these three will be given to you you just have to

will be given to you you just have to put it there in the formula and find out

put it there in the formula and find out mirror that's it

mirror that's it and if you see PVR divided by p v i to

and if you see PVR divided by p v i to the power 1 over n n is number of years

the power 1 over n n is number of years okay

okay now

now before we move on to the discounted

before we move on to the discounted payment

payment period will do a small test

period will do a small test understanding on mirror also

understanding on mirror also foreign

value and irr for which we have formula in spreadsheet same way mirror also have

in spreadsheet same way mirror also have a spreadsheet function which can save

a spreadsheet function which can save your time

your time but make sure that you should know the

but make sure that you should know the way we do

way we do manually

manually as well as you should know how to use

as well as you should know how to use the formula so that in case if you are

the formula so that in case if you are not able to do the manual way

not able to do the manual way to save time only to save time you can

to save time only to save time you can use the mirr function

use the mirr function okay so here

okay so here it's a standard project you can see 20

it's a standard project you can see 20 000 outflow and rest all is inflow and

000 outflow and rest all is inflow and cost of capital is eight percent you

cost of capital is eight percent you just need to find mirror it's very easy

just need to find mirror it's very easy I'm not going to show you the answer PVR

I'm not going to show you the answer PVR divided by p v i

1 to the power of n into

into 1

1 I kind of forgot the formula also

I kind of forgot the formula also it's one into a one plus re

it's one into a one plus re okay anyway we'll check the formula list

corre correct so what is the rate uh return phase just

so what is the rate uh return phase just add all these four

add all these four but you need to find the present value

but you need to find the present value by the way eight percent

by the way eight percent of all those four add-on once you get it

of all those four add-on once you get it put it here and in the denominator it

put it here and in the denominator it will be twenty thousand only

will be twenty thousand only to the power 1 over n one over four

to the power 1 over n one over four don't take this 0 is 1 2 3 4 5 and write

don't take this 0 is 1 2 3 4 5 and write no you check the last column it's 4 that

no you check the last column it's 4 that means to the power 4 into 1 plus re R is

means to the power 4 into 1 plus re R is what

what eight percent

eight percent so only the top part you need to find

so only the top part you need to find out present value of return fees

okay that also uh

that also uh they have already got it present value

they have already got it present value is 2 to 340. for for your one to four

is 2 to 340. for for your one to four cash flow PBS 20 000. okay so this over

cash flow PBS 20 000. okay so this over twenty thousand to the power one over

twenty thousand to the power one over four into one point zero eight plus one

four into one point zero eight plus one plus eight plus if you see mirror is

eleven percent per year okay you need to do this calculation

okay you need to do this calculation first

first when you're doing this calculation 2 to

when you're doing this calculation 2 to 340 divided by 20 000 to the power 1

340 divided by 20 000 to the power 1 over 4 needs to be done first

over 4 needs to be done first before you multiply by 1.08

before you multiply by 1.08 make sure you know how to put the powers

make sure you know how to put the powers 1 to the power 4 manually as well as in

1 to the power 4 manually as well as in the

the back in your calculator and also in the

back in your calculator and also in the Excel because you even your CB platform

Excel because you even your CB platform has this thing

has this thing online camera I mean the calculator is

online camera I mean the calculator is there

so eleven percent okay this you need to find out

find out 2 to 340 it is simply they have just

2 to 340 it is simply they have just taken eight thousand twelve thousand

taken eight thousand twelve thousand four thousand two thousand and taken

four thousand two thousand and taken eight percent

eight percent okay so you can multiply this by one

okay so you can multiply this by one divided by one point zero eight one

divided by one point zero eight one divided by 1.08 to the power two one

divided by 1.08 to the power two one divided by 1.08 to the power 3 1 divided

divided by 1.08 to the power 3 1 divided by 1.08 to the power 4 multiply this

by 1.08 to the power 4 multiply this with and you will get the number and add

with and you will get the number and add all the four and you will get the sum of

all the four and you will get the sum of all the

all the so now we are going to go to the fourth

so now we are going to go to the fourth that is discounted payback period

so after Net Present Value irr mirr we are moving on to the fourth which is

are moving on to the fourth which is discounted payback period now if you

discounted payback period now if you have noticed in all these things one

have noticed in all these things one thing is common what is it

thing is common what is it tell me

tell me one thing which is common is just look

one thing which is common is just look at the title of the head uh title

at the title of the head uh title The Heading of the topic

The Heading of the topic cash flow

cash flow we all these four methods are dealing

we all these four methods are dealing with cash flow

with cash flow Net Present Value irr mirr and

Net Present Value irr mirr and discounted payback period and even after

discounted payback period and even after this the next page we are going to study

this the next page we are going to study all deals with cash flow

all deals with cash flow okay

okay so discounted payback period discounted

so discounted payback period discounted payback period we you know what is

payback period we you know what is payback fee

payback fee it is the same just that here they are

it is the same just that here they are taking the present value of money into

taking the present value of money into account

account different right they're discounting it

same this also measures the length of time before the discounted cash flow

time before the discounted cash flow returns from the project cover the

returns from the project cover the initial investment

initial investment how long does it take for you to recover

how long does it take for you to recover your initial investment

okay basic definition same for payback period here also the

same for payback period here also the shorter the discounted payback period

shorter the discounted payback period the better it is the more attractive the

the better it is the more attractive the project is because long if it takes

project is because long if it takes project becomes very risky

project becomes very risky so before we go on to the Macaulay

so before we go on to the Macaulay duration we are going to do a small

duration we are going to do a small question

question on discounted payback period

okay illustration one discounted payback period okay they've already done it for

period okay they've already done it for you as you can see the solution

you as you can see the solution but I'm going to teach you how they have

but I'm going to teach you how they have arrived to that solution

arrived to that solution so this all

so this all same cost of capital same just find the

same cost of capital same just find the discounted payback period how do you

discounted payback period how do you find the discounted payback period for

find the discounted payback period for that you need discounted cash flow

that you need discounted cash flow twenty thousand okay twenty thousand but

twenty thousand okay twenty thousand but rest all you need to find the discount

rest all you need to find the discount how

how just take this 8000 divided by 1.08 I

just take this 8000 divided by 1.08 I mean this is to the power one take this

mean this is to the power one take this divide by 1.08 to the power to or

divide by 1.08 to the power to or multiply oh sorry 12 000 multiplied by 1

multiply oh sorry 12 000 multiplied by 1 divided by 1.08 to the power 2 or is the

divided by 1.08 to the power 2 or is the same thing because 12 000 into one is

same thing because 12 000 into one is twelve thousand so you can rather 12 000

twelve thousand so you can rather 12 000 divided by 1.08 to the power 2.

divided by 1.08 to the power 2. so you just keep increasing the power

so you just keep increasing the power here

here eight thousand divided by 1.08 12 000

eight thousand divided by 1.08 12 000 divided by one point zero to the power

divided by one point zero to the power to four thousand divided by 1.08 to the

to four thousand divided by 1.08 to the power three like this

power three like this you find out

okay fourth year they didn't do because you

fourth year they didn't do because you want to find a discounted payback period

want to find a discounted payback period okay fourth year also if you want you

okay fourth year also if you want you can do

can do okay fourth year also you can have there

okay fourth year also you can have there not an issue but maybe they have

not an issue but maybe they have recovered it within three years or two

recovered it within three years or two years that's why they didn't put the

years that's why they didn't put the last year if you see

last year if you see so you take this discounted cash flow

so you take this discounted cash flow after that you need to find cumulative

after that you need to find cumulative discounted cash flow first tier 20 000

discounted cash flow first tier 20 000 that means year zero one will be how

that means year zero one will be how much

much from this 20 000 you are receiving seven

from this 20 000 you are receiving seven four zero seven so deduct seven four

four zero seven so deduct seven four zero seven from twenty thousand it will

zero seven from twenty thousand it will be twelve five nine three negative

be twelve five nine three negative still you didn't recover

still you didn't recover then you received 10 to 88 in the second

then you received 10 to 88 in the second year still some amount is there you

year still some amount is there you didn't recover in the second year also

didn't recover in the second year also entirely third year if you are receiving

entirely third year if you are receiving more than two three zero five we are

more than two three zero five we are receiving three one seven five so here

receiving three one seven five so here you are having a positive figure that

you are having a positive figure that means you are receiving it

means you are receiving it between two and three years

between two and three years so the discounted payback period will be

so the discounted payback period will be between two and three years if you see

between two and three years if you see it will be two point something because

it will be two point something because between two and three is not exactly two

between two and three is not exactly two year not three year olds

year not three year olds how do you find that fraction you know

how do you find that fraction you know it's two years for sure

it's two years for sure okay

okay because it's in the third year but it's

because it's in the third year but it's age 70.

age 70. second year okay

second year okay only for the fraction you need to do

only for the fraction you need to do this to find out Point how much how do

this to find out Point how much how do you find that fraction

you find that fraction use this cumulative discounted cash flow

use this cumulative discounted cash flow the last cumulated discount cash flow

the last cumulated discount cash flow where you are having a negative balance

where you are having a negative balance that is 2305 divide by the next year's

that is 2305 divide by the next year's discounted cash flow three one seven

discounted cash flow three one seven five and this method is fixed by any

five and this method is fixed by any discounted payback period member is it

discounted payback period member is it cumulative discount cash flow the

cumulative discount cash flow the negative over next year's inflow 3175

negative over next year's inflow 3175 add it with two years because you know

add it with two years because you know it is after the second year

it is after the second year that you are receiving so it will be so

that you are receiving so it will be so this will give you 0.73 so 0.73 add with

this will give you 0.73 so 0.73 add with two years 2.73 years

the next method is mccallo duration what is this duration about

what is this duration about this duration measures the average time

this duration measures the average time to recover the present value of the

to recover the present value of the project if cash flows are discounted at

project if cash flows are discounted at the cost of capital

the cost of capital okay

if you're not understanding the definition do not worry because we have

definition do not worry because we have a formula for this also to calculate

a formula for this also to calculate okay so duration this duration captures

okay so duration this duration captures both time value of money and the whole

both time value of money and the whole of the cash flow if you have seen that

of the cash flow if you have seen that in the discounted payback period and PDF

in the discounted payback period and PDF we often ignore the cash flows after we

we often ignore the cash flows after we recover the amount but in my color

recover the amount but in my color duration they take the whole cash flow

duration they take the whole cash flow into consideration with the time value

into consideration with the time value of money

okay then

then how do you evaluate projects with higher

how do you evaluate projects with higher duration carries more risk lower

duration carries more risk lower duration is good

duration is good okay

okay and discounted payback may lead to

and discounted payback may lead to project to be discarded that has highly

project to be discarded that has highly favorable cash flow after the payback

favorable cash flow after the payback date see you the problem with the

date see you the problem with the discounted payback is after the cash

discounted payback is after the cash after you receive I mean maybe towards

after you receive I mean maybe towards the end you might be having highly

the end you might be having highly favorable cash after the payback date

favorable cash after the payback date but you do not take that into

but you do not take that into consideration but Michaela duration

consideration but Michaela duration takes the entire cash flow into

takes the entire cash flow into consideration okay

consideration okay how do you compare comparison of my

how do you compare comparison of my calorie duration and modified duration

okay my calorie duration is the name given to the weighted average time

given to the weighted average time until cash flows are received

until cash flows are received the weighted average time until cash

the weighted average time until cash flows are received and it is measured in

flows are received and it is measured in years

years okay modify duration is the name given

okay modify duration is the name given to the price sensitivity and its

to the price sensitivity and its percentage change in price for a unit

percentage change in price for a unit engineer for example if uh interest

engineer for example if uh interest changes

changes okay

okay enjoy those changes how much will your

enjoy those changes how much will your modify duration I mean

modify duration I mean how much will the duration change

how much will the duration change how sensitive it is

how sensitive it is does it change by a small amount in

does it change by a small amount in price or it needs a big change in a

price or it needs a big change in a price if it changes by a small amount of

price if it changes by a small amount of price it's very price sensitive

price it's very price sensitive okay

okay will definitely come to this

will definitely come to this with the calculations and all I know

with the calculations and all I know that on reading theory is a bit uh not

that on reading theory is a bit uh not you're not understanding the picture

you're not understanding the picture right now but with calculations you'll

right now but with calculations you'll be able to understand it better

be able to understand it better Michaela duration and modified duration

Michaela duration and modified duration slightly they differ

slightly they differ it's not the same thing my color

it's not the same thing my color duration modified duration are two

duration modified duration are two separate things

separate things okay

okay and there's a relationship between these

and there's a relationship between these two

two assuming that cash flows are discounted

assuming that cash flows are discounted annually okay annually you have to

annually okay annually you have to discount cash flow

discount cash flow this is the uh the the relationship

this is the uh the the relationship modified duration is equals to Mercado

modified duration is equals to Mercado duration divided by 1 plus cost of

duration divided by 1 plus cost of capital that means to find modified

capital that means to find modified duration you first need to find my

duration you first need to find my calendar duration because without that

calendar duration because without that you cannot find modified duration so my

you cannot find modified duration so my calorie duration divided by one plus

calorie duration divided by one plus cost of capital

cost of capital okay therefore in the above illustration

okay therefore in the above illustration where the project cash flows were

where the project cash flows were discounted at eight percent just now we

discounted at eight percent just now we saw an illustration right frigid cash

saw an illustration right frigid cash flows were discounted at eight percent

flows were discounted at eight percent okay and uh

okay and uh my calendar duration was 1.94 years okay

my calendar duration was 1.94 years okay we'll just do a question test

we'll just do a question test understanding five to understand this

understanding five to understand this okay in that

okay in that I've not put that illustration here but

I've not put that illustration here but in there my calorie duration was 1.94

in there my calorie duration was 1.94 year okay let's assume my current

year okay let's assume my current duration is 1.94 so 1.94 divided by one

duration is 1.94 so 1.94 divided by one plus cost of capital that is one plus

plus cost of capital that is one plus eight percent one point nine one divided

eight percent one point nine one divided by 1.0 it will give you a modified

by 1.0 it will give you a modified duration of 1.8

duration of 1.8 that means

that means 1.8 is the modified duration

1.8 is the modified duration okay now let us do a question where we

okay now let us do a question where we are going to cover both this modified

are going to cover both this modified duration as well as my calorie duration

the color duration okay you need to calculate here

okay you need to calculate here projects discounted payback and

projects discounted payback and McCullough duration okay

but remember uh without finding Michaela duration you

uh without finding Michaela duration you cannot find modified duration okay

so modified duration is nothing but Michaela duration developed by one plus

Michaela duration developed by one plus cost of capital

cost of capital now we have this project with falling

now we have this project with falling cash flow 127 is negative and this is

cash flow 127 is negative and this is for six years cost of capital is 10 so

for six years cost of capital is 10 so first we'll find the projected

first we'll find the projected discounted Payback

discounted Payback okay so just list all the net cash flow

okay so just list all the net cash flow like this then find the discount Factor

like this then find the discount Factor at 10 and find the present value once

at 10 and find the present value once you get it

you get it you need to find the cumulative present

you need to find the cumulative present value okay list everything okay this is

value okay list everything okay this is the same thing you're going to list down

the same thing you're going to list down here after that cumulative keep adding

here after that cumulative keep adding minus 127 plus 33 becomes negative you

minus 127 plus 33 becomes negative you see amount is reducing falling down

see amount is reducing falling down because you're getting more and more in

because you're getting more and more in flow

flow until here okay you stop here

until here okay you stop here no need to proceed ahead stop at 6.7 and

no need to proceed ahead stop at 6.7 and 50.4 so discounted payback period you

50.4 so discounted payback period you know it's two and three between two and

know it's two and three between two and three years so between two and three is

three years so between two and three is always take the lower don't take three

always take the lower don't take three years plus it should be two years plus

years plus it should be two years plus so two years plus the fraction fraction

so two years plus the fraction fraction will be I have told you the negative was

will be I have told you the negative was 50.4 the last negative cumulative divide

50.4 the last negative cumulative divide by 57.1

this is this 57.1 not 6.7 57.1 always your this denominator has to be higher

your this denominator has to be higher than your numerator understand that

than your numerator understand that okay because this amount should not be

okay because this amount should not be more than one it should be zero point

more than one it should be zero point something always it will be less than

something always it will be less than one always the fraction that's how you

one always the fraction that's how you get two point you know

so here you got 0.9 that's how you got 2.92 plus 0.9 2.9 years

2.92 plus 0.9 2.9 years no

no that was discounted payback period

that was discounted payback period now we are going to the Michaela

now we are going to the Michaela duration

duration they just have Road duration

they just have Road duration here

here once you have got the present value here

once you have got the present value here also you need the present value both

also you need the present value both discounted payback period and my color

discounted payback period and my color duration needs present value at 10 so

duration needs present value at 10 so write it

write it copy paste it okay now when you're

copy paste it okay now when you're working in the Michaela duration it is

working in the Michaela duration it is present value into years

present value into years modify duration we know make calorie

modify duration we know make calorie duration divide by one plus cost of

duration divide by one plus cost of capital that we don't have to

capital that we don't have to with that also you can find out from

with that also you can find out from here but Michaela duration is present

here but Michaela duration is present value into number of years

value into number of years for example here 33.6 it will be into 1

for example here 33.6 it will be into 1 because this is year one this is year

because this is year one this is year two year three year four year five year

two year three year four year five year six so multiply 43 into 286 you see

six so multiply 43 into 286 you see double 57.1 into 3 47.1 into 4 here they

double 57.1 into 3 47.1 into 4 here they have shown you also

have shown you also I mean sorry they have just added okay

I mean sorry they have just added okay so multiply with the number of year once

so multiply with the number of year once you get it

you get it this add all this

this add all this add all this here

okay once you add it you need to divide it by what

it by what you need to divide it by this present

you need to divide it by this present value

value leave 127 aside so 33.6 43 57 you see

leave 127 aside so 33.6 43 57 you see this on the top part 16.4 divided you

this on the top part 16.4 divided you need to divide it this down part add

need to divide it this down part add some of the downward divided by some of

some of the downward divided by some of the the numerator

the the numerator so 714.2 divided by 224.5

so 714.2 divided by 224.5 definitely definitely your lower part

definitely definitely your lower part will be higher than your upper part

will be higher than your upper part because that is a multiplication with

because that is a multiplication with the number of years you are doing that's

the number of years you are doing that's why this is 714.2

why this is 714.2 so once you do it you automatically will

so once you do it you automatically will get it

get it in terms of

in terms of decimal 3.2 years it will be in years by

decimal 3.2 years it will be in years by the way okay my calorie duration

the way okay my calorie duration now this question is not asked but if I

now this question is not asked but if I tell you to find modified duration how

tell you to find modified duration how do you find out

tell me it is mccallo duration divided by one

it is mccallo duration divided by one plus cost of capital

so your modified duration is what 3.2 1 plus cost of Capital One plus ten

plus cost of Capital One plus ten percent that means 1.1

percent that means 1.1 how much

you see this is your modified duration

so that's it for my calorie duration and modified duration now we are moving on

modified duration now we are moving on to multiple uh multiple Capital

to multiple uh multiple Capital rationing

multi-period Capital rationing now in your financial management you have went

your financial management you have went through single period right Capital

through single period right Capital rationing here we are going to go

rationing here we are going to go through multi-period Capital resting but

through multi-period Capital resting but for your AFM syllabus

for your AFM syllabus uh you are already uh supposed to

uh you are already uh supposed to discuss okay discussion part

discuss okay discussion part not much will be asked from here and

not much will be asked from here and sometimes this is not asked but knowing

sometimes this is not asked but knowing it's always good

it's always good okay Capital rationing means what when

okay Capital rationing means what when you're

you're when you have insufficient funds to do

when you have insufficient funds to do everything that you want it could be

everything that you want it could be anything maybe your labor is limited see

anything maybe your labor is limited see if we know resources are limited right

if we know resources are limited right maybe the funds may be

maybe the funds may be the skills it could be anything

the skills it could be anything so the shortage of funds may be for

so the shortage of funds may be for single period if it's for single period

single period if it's for single period it is known as single period Capital

it is known as single period Capital rationing that is easy to find out

rationing that is easy to find out through profitability indexes but we are

through profitability indexes but we are not worried about it here in AFM that we

not worried about it here in AFM that we have done it in financial management

have done it in financial management we rank according to the profitability

we rank according to the profitability index and then we see okay

index and then we see okay second is

second is your multi-period Capital rationing that

your multi-period Capital rationing that will be thinking I mean we'll be working

will be thinking I mean we'll be working on it in AFM Pi profitability index how

on it in AFM Pi profitability index how is it worked out why did I mention it

is it worked out why did I mention it here because this is an assumed

here because this is an assumed knowledge for your AFM from your

knowledge for your AFM from your financial management

financial management once you come to FM whatever you have

once you come to FM whatever you have learned in financial management entirely

learned in financial management entirely you cannot forget because in AFM it is

you cannot forget because in AFM it is assumed that you will be doing those

assumed that you will be doing those knowledge okay that's why I've mentioned

knowledge okay that's why I've mentioned it here it's just television

it here it's just television profitability index is equals to Net

profitability index is equals to Net Present Value divided by present value

Present Value divided by present value of the capital invested

of the capital invested net present value means you deduct your

net present value means you deduct your initial investment present value means

initial investment present value means only the

only the without your initial investment

without your initial investment more than one period that means

more than one period that means extending more than one years you have

extending more than one years you have limited Capital rationing

revision of linear programming only for multi-period Capital rationing we are

multi-period Capital rationing we are going through this one is linear

going through this one is linear programming

programming this does not come in single PDF their

this does not come in single PDF their YouTube profitability index and rank

YouTube profitability index and rank here you don't solve anything but you do

here you don't solve anything but you do linear programming you just need to know

linear programming you just need to know how to do it that's it you are not going

how to do it that's it you are not going to solve the equation or anything this

to solve the equation or anything this is formulated in three stages number one

is formulated in three stages number one you define the unknown I'm going to show

you define the unknown I'm going to show you how Define the unknown second

you how Define the unknown second formula the objective function third you

formula the objective function third you express the constraints in terms of

express the constraints in terms of inequalities including the

inequalities including the non-negativities

non-negativities okay if you're not understanding these

okay if you're not understanding these three functions no need it's fine forget

three functions no need it's fine forget about it we'll see we do it with a

about it we'll see we do it with a question

see if a question is asked about multi-period Capital rationing this is

multi-period Capital rationing this is the way it will be asked one way only

the way it will be asked one way only this will be asked there is no other way

this will be asked there is no other way so if you know this that's good

so if you know this that's good okay

okay you need to form an equation basically

you need to form an equation basically using this if you can see there are

using this if you can see there are three projects and it has all the three

three projects and it has all the three projects have for two years project a b

projects have for two years project a b and c and you are given the Netflix and

and c and you are given the Netflix and value also from all the three projects

value also from all the three projects okay now you have some constraint in

okay now you have some constraint in year zero year one year two two million

year zero year one year two two million three million seven million

three million seven million okay this is the amount that you can

okay this is the amount that you can spend now you need to form an equation

spend now you need to form an equation based on this okay so first step one you

based on this okay so first step one you have to define the unknown

that means you are using algebra here okay

okay you are annoting something is for

you are annoting something is for something because in an equation math

something because in an equation math equation what do you do you write right

equation what do you do you write right let's assume a is this B is this C is

let's assume a is this B is this C is this same thing you are doing it

this same thing you are doing it so you can take any variables here they

so you can take any variables here they are taking ABC you can take x y z you

are taking ABC you can take x y z you can take any letter you can take okay

can take any letter you can take okay let's say ABC so let a b c a project a b

let's say ABC so let a b c a project a b Project B C project C okay proportion of

Project B C project C okay proportion of projectory undertaken

projectory undertaken and let's Z another variable you need

and let's Z another variable you need for the Net Present Value so let Z the

for the Net Present Value so let Z the net present value of the combination of

net present value of the combination of the project selected

the project selected and remember you are not required to

and remember you are not required to solve the solution only equation you

solve the solution only equation you have to make and you have to formulate

have to make and you have to formulate and appropriate Capital rationing model

and appropriate Capital rationing model that maximizes the Net Present Value

that maximizes the Net Present Value that means you have to get the maximum

that means you have to get the maximum Net Present Value okay

Net Present Value okay is it is it taking project one and two

is it is it taking project one and two will be more or project sorry a b or a

will be more or project sorry a b or a and C or B C B and C or just a you need

and C or B C B and C or just a you need to

to for that we'll be doing this equation

for that we'll be doing this equation so this is the first Define the unknown

so this is the first Define the unknown okay just go through it

okay just go through it whatever videos you are taking it is the

whatever videos you are taking it is the proportion of the project that you're

proportion of the project that you're going to undertake it is for anything

going to undertake it is for anything any question if you get also

any question if you get also only the variables you can change later

only the variables you can change later you can change the test remains

you can change the test remains everything the same second is this is

everything the same second is this is the second step I'm going to put the

the second step I'm going to put the number

number because you need this one unknown

because you need this one unknown a stands for what b stands for what

a stands for what b stands for what second you are formulating the objective

second you are formulating the objective function what is objective function to

function what is objective function to maximize your Net Present Value remember

maximize your Net Present Value remember so if you're working on Net Present

so if you're working on Net Present Value you have to put a variable for

Value you have to put a variable for that also Z

that also Z okay now numbers you will get from here

okay now numbers you will get from here these are the Net Present Value three

these are the Net Present Value three zero fifty a

zero fifty a y a into a

y a into a multiply a that means proportion of

multiply a that means proportion of project a you are taking

project a you are taking plus this plus this into the variable

plus this plus this into the variable because here you have already taken a b

because here you have already taken a b and c you are already going to deal with

and c you are already going to deal with this in the equation and this in the

this in the equation and this in the equation you are not going to say

equation you are not going to say project a b and c okay from here onwards

project a b and c okay from here onwards that's why we have defined the unknowns

that's why we have defined the unknowns in the first step itself

in the first step itself but this is the proportion of a this is

but this is the proportion of a this is the proportion of B this is the

the proportion of B this is the proportion of c z is the Net Present

proportion of c z is the Net Present Value so is that when you are taking Z

Value so is that when you are taking Z will be equal to this is the project Net

will be equal to this is the project Net Present Value from the project a that

Present Value from the project a that means a

means a plus add all the three

plus add all the three always you have to do it like this only

always you have to do it like this only Net Present Value add all the three if

Net Present Value add all the three if it's four then four then five whatever B

it's four then four then five whatever B and C this is the Net Present Value from

and C this is the Net Present Value from B this is the Net Present Value from

B this is the Net Present Value from Project C but you are not going to

Project C but you are not going to approach it a b and z are going to write

approach it a b and z are going to write a b and c

a b and c okay the objective function to be

okay the objective function to be maximizes this

now third

third Express the constraints in terms of

Express the constraints in terms of inequalities including the non-negative

inequalities including the non-negative they could there cannot be any negative

they could there cannot be any negative it should be

it should be 0 or more than it positive only

0 or more than it positive only that means in terms of time you are

that means in terms of time you are going to write now time 0 Time 1 time 2.

see this other these are the limitations 2 million 300 700 000.

2 million 300 700 000. when you are writing it how do you solve

when you are writing it how do you solve the equation based on this

500 500 a wait a minute to open it a

wait a minute to open it a okay when you're writing it it will be

okay when you're writing it it will be like this 500A because this is projected

like this 500A because this is projected this is Project B so 600 plus you have

this is Project B so 600 plus you have to keep adding all project C so 1000c

to keep adding all project C so 1000c same way for year one and two also you

same way for year one and two also you have to do I'm just showing you for your

have to do I'm just showing you for your zero so 500 a plus 600 B plus 1000 C

zero so 500 a plus 600 B plus 1000 C less or equal to always write less or

less or equal to always write less or equal to less or equal to less or equal

equal to less or equal to less or equal to

to this is the Capital the the limit two

this is the Capital the the limit two million three million 700

million three million 700 so that equation has to be less than

so that equation has to be less than less or equal to 2000 obviously less

less or equal to 2000 obviously less than 2 hours 2000 is the limit 300 and

than 2 hours 2000 is the limit 300 and 700 for Year One

700 for Year One zero one and two

zero one and two also you have to write this

a will be less so

will be less so a will be greater equal to zero

a will be greater equal to zero c will be less or equal to 1 and B

look at this you can just forget about it

it but yeah

so this is your linear programming this is known as linear programming just you

is known as linear programming just you are writing a question

foreign simulation

what is Monte Carlo simulation you know what a simulation

you know what a simulation this simulation is a little complex

this simulation is a little complex introduced by Monte Carlo hence Monte

introduced by Monte Carlo hence Monte Carlo simulation where you test

Carlo simulation where you test different scenarios

different scenarios right it's like you can say in your

right it's like you can say in your Excel it's like a what-if analysis you

Excel it's like a what-if analysis you check different uh you test with your

check different uh you test with your input variables you change the input

input variables you change the input variables and see what is the impact on

variables and see what is the impact on the output

the output how much video it has been changed how

how much video it has been changed how much your returns are likely to change

much your returns are likely to change if you change your input variables for

if you change your input variables for example for Net Present Value let's say

example for Net Present Value let's say uh sales or your cost just change one of

uh sales or your cost just change one of the figure and see how much your Net

the figure and see how much your Net Present Value needs to fall I mean how

Present Value needs to fall I mean how much will it fall

much will it fall right

right or even uh what change in variable will

or even uh what change in variable will lead your Net Present Value to become to

lead your Net Present Value to become to zero or even negative

these are like your estimations you are predicting

predicting your future outcomes right

it's like you are Incorporated to see whatever decisions you take investment

whatever decisions you take investment appraisal return is fine but what about

appraisal return is fine but what about the risk we also need to take a risk

the risk we also need to take a risk into the account

into the account hence we are studying various models to

hence we are studying various models to incorporate risk into your investment

incorporate risk into your investment oppressor

oppressor okay one example is expected values okay

okay one example is expected values okay this is done through your probability

this is done through your probability analysis we'll see shortly how it is

analysis we'll see shortly how it is done

done you see how risk it is based on your

you see how risk it is based on your expected higher your expected value

expected higher your expected value better it is lower your expected value

better it is lower your expected value you don't go for the project because

you don't go for the project because it's considered to be very risky

it's considered to be very risky use of capm model to derive a discount

use of capm model to derive a discount rate you know your Capital asset pricing

rate you know your Capital asset pricing model I'm sure all of you know because

model I'm sure all of you know because you cannot come to FM without doing

you cannot come to FM without doing financial management so you know what is

financial management so you know what is capital asset pricing model where we

capital asset pricing model where we find a discount rate right

find a discount rate right so higher that discount rate higher the

so higher that discount rate higher the risk that is second method of finding

risk that is second method of finding risk third is

risk third is through sensitivity analysis and

through sensitivity analysis and simulation

simulation what is sensitivity analysis also will

what is sensitivity analysis also will do to an example

do to an example now first let us go through probability

now first let us go through probability analysis okay for example sales could

analysis okay for example sales could either be 1 million or 1.5 million

either be 1 million or 1.5 million probability of sale being 1 million is

probability of sale being 1 million is 35 of 1.5 is 65 okay so this is how you

35 of 1.5 is 65 okay so this is how you are going to calculate expected sales

are going to calculate expected sales you basically multiply your probability

you basically multiply your probability with the outcome so 1 million into 35

with the outcome so 1 million into 35 percent plus 1.5 million into 65 percent

percent plus 1.5 million into 65 percent and you get one three to fifty thousand

1.3.1.325 million that is our expected sales

sales okay but there is a problem with this

okay but there is a problem with this method

method the main problem with the expected value

the main problem with the expected value calculation is what

that whatever the value you might get it might not correspond to any possible

might not correspond to any possible outcomes

outcomes how can you be social that this is the

how can you be social that this is the amount that you owe at exactly going to

amount that you owe at exactly going to get

right it just gives one figure with one figure you cannot decide anything rather

figure you cannot decide anything rather it's not giving a range of figures just

it's not giving a range of figures just giving you one figure

okay and second this only works when

and second this only works when something is repeated you see

something is repeated you see probabilities are based on repeated

probabilities are based on repeated repetitive events that's occurring

repetitive events that's occurring that's how you give a percentage to

that's how you give a percentage to something

something probability

probability so if it's for a one of uh even though

so if it's for a one of uh even though one of let's say the investment that you

one of let's say the investment that you are going to do Investments are of

are going to do Investments are of different nature no two Investments are

different nature no two Investments are same so one of investment so in that

same so one of investment so in that using probability analysis will not help

using probability analysis will not help because you are not going to get the

because you are not going to get the probability

probability so expected value for that case is not

so expected value for that case is not useful

useful second is conditional probability okay

second is conditional probability okay there is another thing known as

there is another thing known as conditional probability based on certain

conditional probability based on certain conditions if it is fulfilled

conditions if it is fulfilled certain actions will happen

certain actions will happen okay and this article is there there's a

okay and this article is there there's a technical article on conditional

technical article on conditional probability on your HCA website please

probability on your HCA website please do go check and read it out

do go check and read it out okay then we are moving on to

okay then we are moving on to sensitivity analysis

sensitivity analysis sensitivity analysis measures the change

sensitivity analysis measures the change in a particular variable

in a particular variable okay that means one variable changes

okay that means one variable changes what would be the impact on your net

what would be the impact on your net present value

how much change is needed in that particular variable for your Net Present

particular variable for your Net Present Value to become zero that is the meaning

Value to become zero that is the meaning of sensitivity analysis we are going to

of sensitivity analysis we are going to do with numbers and all and it can be

do with numbers and all and it can be calculated as like this this is the

calculated as like this this is the method

method whatever the net present value of the

whatever the net present value of the project first find it divide by the

project first find it divide by the present value of cash flows affected by

present value of cash flows affected by the estimate whatever you are working

the estimate whatever you are working with one particular variable load you

with one particular variable load you have to take for that present value of

have to take for that present value of cash flow

cash flow okay into hundred percent higher the

okay into hundred percent higher the percentage better it is lower the

percentage better it is lower the percentage it's very difficult that

percentage it's very difficult that means it's more sensitive because

means it's more sensitive because something changing by a smaller amount

something changing by a smaller amount is highly possible Right

is highly possible Right rather than something changing let's say

rather than something changing let's say price change okay

price change okay change in price by one or two percent

change in price by one or two percent it's more likely or changing uh price

it's more likely or changing uh price changing by sixty percent up or down is

changing by sixty percent up or down is more likely which one one or two percent

more likely which one one or two percent is more likely right so that's more

is more likely right so that's more risky

risky but if it's the 60 High the percentage

but if it's the 60 High the percentage better that means it's less sensitive

better that means it's less sensitive because uh something changing by sixty

because uh something changing by sixty percent fifty percent very unlikely not

percent fifty percent very unlikely not in the short term analyst

in the short term analyst so that's how you interpret then we are

so that's how you interpret then we are moving on to simulation sensitivity

moving on to simulation sensitivity analysis and simulation is not the same

analysis and simulation is not the same thing

thing simulation okay there's a problem with

simulation okay there's a problem with sensitivity analysis that's why we are

sensitivity analysis that's why we are moving towards simulation what is the

moving towards simulation what is the main problem

main problem the main problem is that it allows us to

the main problem is that it allows us to assess the impact of one variable only

assess the impact of one variable only for sensitivity analysis only one

for sensitivity analysis only one variable you change and see what is the

variable you change and see what is the impact but in reality is it possible

impact but in reality is it possible only one variable is affecting sales

only one variable is affecting sales price no so many other things are there

price no so many other things are there so in stimulation you change all the

so in stimulation you change all the variables and see what is the impact on

variables and see what is the impact on the net present value

the net present value okay

okay second

second there are they employ random numbers to

there are they employ random numbers to select specimen values for each variable

select specimen values for each variable for simulation those things and all you

for simulation those things and all you don't need to know I'm just saying for

don't need to know I'm just saying for your understanding purpose

your understanding purpose this means this is repeated a large

this means this is repeated a large number of times until a distribution of

number of times until a distribution of Net Present Value emerge

that means you will have a table normal distribution table is there for

distribution table is there for simulation okay so by analyzing this

simulation okay so by analyzing this distribution The Firm can then decide

distribution The Firm can then decide whether to proceed with the project or

whether to proceed with the project or not

not okay for example if ninety percent of

okay for example if ninety percent of the generated Net Present values are

the generated Net Present values are positive

okay what does it mean that is only five percent chances are there that Net

percent chances are there that Net Present Value will be small negative 45

Present Value will be small negative 45 but 95 chances are is positive right

so before we move on to our next that is value at risk we first need to do some

value at risk we first need to do some questions on each of the simulation

questions on each of the simulation sensitivity analysis expected value

now this is a question on expected value okay example so there's 60 chance that

okay example so there's 60 chance that sales will be high

sales will be high that is 3 million in year one and forty

that is 3 million in year one and forty percent chance that year one says will

percent chance that year one says will be below 1 million

be below 1 million okay this is like a conditional

okay this is like a conditional probability you can see you need to work

probability you can see you need to work out on conditional probability okay so

out on conditional probability okay so if the sales in year one are high that

if the sales in year one are high that is three million sales in year two will

is three million sales in year two will be either 5 million or 4 million

be either 5 million or 4 million probability is also given 30 and 70

probability is also given 30 and 70 percent

percent okay if the moment if it's there it's a

okay if the moment if it's there it's a conditional probability if this happens

conditional probability if this happens that will happen if sales are high only

that will happen if sales are high only sales in year two will be either this or

sales in year two will be either this or that

that if sales in year one are low then sales

if sales in year one are low then sales in year 2 will be either this or this

in year 2 will be either this or this probably again are given

probably again are given so now you need to find out what is the

so now you need to find out what is the expected sales in year one and what is

expected sales in year one and what is the expected sales in year two

the expected sales in year two so in expected sales in year one will be

so in expected sales in year one will be okay if it's high

so if the there are 60 chance that sales will be

there are 60 chance that sales will be high

that means 60 into 3 million plus 40 into 1 million high and low you add in

into 1 million high and low you add in this this is it

this this is it then

for year two year one is okay your one is 2.2 year two it's a

your one is 2.2 year two it's a conditional probability okay when you

conditional probability okay when you see this at once it looks uh too much of

see this at once it looks uh too much of work where to start break it down into

work where to start break it down into small small pieces okay

so let's start with when sales are high okay in year one sales is high is 0.6

okay in year one sales is high is 0.6 percent

percent into

into okay you need to multiply

year two this or this see or is added okay or means you add always and

okay or means you add always and multiplication if it's and if this

multiplication if it's and if this happens that will happen it's an and and

happens that will happen it's an and and probabilities you always multiply all

probabilities you always multiply all probabilities you always add

probabilities you always add that's why there's multiplication

that's why there's multiplication because 0.6

because 0.6 you are assuming High sales 60 High

you are assuming High sales 60 High sales

sales so 0.6 into

so 0.6 into in year two sales will be 5 million at

in year two sales will be 5 million at 30 that's why 0.3 into five plus this

30 that's why 0.3 into five plus this plus because or or

plus because or or four million into seventy percent so

four million into seventy percent so seven four million into seventy percent

seven four million into seventy percent this is one

this is one next if sales are low that is 0.4 into

next if sales are low that is 0.4 into second year sales will be 0.8 into 0.5

second year sales will be 0.8 into 0.5 plus because or 0.2 into 1.5 that is

plus because or 0.2 into 1.5 that is this

this 1.5 0.2 adds

1.5 0.2 adds finally add the both okay this is one

finally add the both okay this is one part

this is another part add both 1 and 2. so it's 2.86 million

understanding so this is how you work out with this one now we are moving on

out with this one now we are moving on to sensitivity analysis

so this is a very good illustration of sensitivity analysis you might be

sensitivity analysis you might be thinking I'm doing less because with

thinking I'm doing less because with just one you will be able to understand

just one you will be able to understand that's how it is okay so here they have

that's how it is okay so here they have given you the sales cost tax everything

given you the sales cost tax everything is there

is there they have even got the net present value

they have even got the net present value okay all those things you don't need to

okay all those things you don't need to do

do our work is to work on the sensitivity

our work is to work on the sensitivity so we are going to work out on the

so we are going to work out on the sensitivity to each variables one to the

sensitivity to each variables one to the sales to the cost to the tax

sales to the cost to the tax okay so first is sensitivity to sales

sensitivity to discount rate and you need to interpret as well at the

and you need to interpret as well at the end remember you have to give your

end remember you have to give your conclusion based on what you find out

conclusion based on what you find out so they didn't take cost but anyway tax

so they didn't take cost but anyway tax rate is there so sensitivity to sales

rate is there so sensitivity to sales that means Net Present Value here was an

that means Net Present Value here was an at present value divided by present

at present value divided by present value of cash flow

value of cash flow affected by the estimate of sales

affected by the estimate of sales affected by the estimate of tax rate

affected by the estimate of tax rate whatever you are working with that

whatever you are working with that present value and into 100 into 100 is

present value and into 100 into 100 is the same thing so here at present value

the same thing so here at present value is 430 this 430

is 430 this 430 000. they have dropped down the three

000. they have dropped down the three zeros because you are dealing with this

zeros because you are dealing with this also in thousands make sure when you're

also in thousands make sure when you're dropping down the three zeros everywhere

dropping down the three zeros everywhere you need to drop down three zeros if you

you need to drop down three zeros if you are taking the whole number 430 000

are taking the whole number 430 000 everywhere you have to deal like that

everywhere you have to deal like that sometimes what happens students very

sometimes what happens students very silly mistake somewhere they drop down

silly mistake somewhere they drop down three zeros other way they are taking

three zeros other way they are taking all the amounts so it becomes very

all the amounts so it becomes very difficult for example you might write

difficult for example you might write for 30 000 divided by one thousand into

for 30 000 divided by one thousand into then the number changes you might get

then the number changes you might get something higher than 100 also which

something higher than 100 also which should not happen

should not happen so 430

so 430 divide by see the best way is if you're

divide by see the best way is if you're confused like that check your numerator

confused like that check your numerator has to always to be less than your

has to always to be less than your denominator

denominator should be otherwise you'll get more than

should be otherwise you'll get more than 100 percent

100 percent okay

okay check this do this calculation this part

check this do this calculation this part and check with this lesson 430 it has to

and check with this lesson 430 it has to be less than 4 30.

I'm sorry not less than 430 has to be more than 4 30. 430 has to be less okay

more than 4 30. 430 has to be less okay numerate has to be less than denominator

numerate has to be less than denominator so

you always have to take the after effect of tax okay that's why they are taking

of tax okay that's why they are taking 1 minus

1 minus one point one minus 0.3 this is tax rate

one point one minus 0.3 this is tax rate tax rate is 30 they're deducting the tax

tax rate is 30 they're deducting the tax rate okay after tax you have to take

rate okay after tax you have to take and which

thousand why because sales in all the yields are thousands if you see but

yields are thousands if you see but after tax you have to take okay

after tax you have to take okay thousand into one minus 0.3 or you can

thousand into one minus 0.3 or you can just simply take thousand into 0.7 after

just simply take thousand into 0.7 after tax right deducting the 30 tax after tax

tax right deducting the 30 tax after tax you want sales

you want sales then into 3.170 what is this 3.170

then into 3.170 what is this 3.170 if I ask you

annuity factor for four years at what percentage

at 10 percent this you can find from the table go to

this you can find from the table go to that table and under annuity Factor what

that table and under annuity Factor what is the percentage ten percent how many

is the percentage ten percent how many years uh

years uh four years

four years ten percent four years it will be 3.170

ten percent four years it will be 3.170 why are they taking annuity Factor

because if you check for cash inflow or outflow if it's same

for cash inflow or outflow if it's same annually you can take annuity Factor

annually you can take annuity Factor simply and saved out of 10 because it's

simply and saved out of 10 because it's one thousand one thousand one thousand

one thousand one thousand one thousand one thousand there is no change in the

one thousand there is no change in the sales value in all the four years is

sales value in all the four years is thousand that's why you can take energy

thousand that's why you can take energy factor and just simply multiply by 3.17

factor and just simply multiply by 3.17 which will be 19.4 percent what does it

which will be 19.4 percent what does it mean that means your sales have to

mean that means your sales have to increase or fall for Net Present Value

increase or fall for Net Present Value to reduce for Net Present Value to

to reduce for Net Present Value to become zero sales has to fall always if

become zero sales has to fall always if sales increases how can your Net Present

sales increases how can your Net Present Value found right so if sales were to

Value found right so if sales were to Fall by 19.4 percent Net Present Value

Fall by 19.4 percent Net Present Value would be zero this is the meaning of it

this is 19.4 in terms of percentage if you are taking in terms of value it has

you are taking in terms of value it has to be 806 per year

anyway you don't need to find this amount percentages is enough

amount percentages is enough that that's they have just did it same

that that's they have just did it same for the tax rate

for the tax rate here

here Net Present Value is 430.

Net Present Value is 430. okay

okay here if you see it's

here if you see it's 45 minus 120. here also annuity Factor

45 minus 120. here also annuity Factor will be same

will be same because for ten percent four years a

because for ten percent four years a native factors 3.17 only you can take

native factors 3.17 only you can take because tax rate is uh same one twenty

because tax rate is uh same one twenty one twenty one twenty one twenty

one twenty one twenty one twenty but if you see you have a tax relief

but if you see you have a tax relief also here on depreciation

also here on depreciation you have to deduct this 120 from 45 so

you have to deduct this 120 from 45 so 45 minus 120 becomes a negative figure

45 minus 120 becomes a negative figure 45 minus 125 minus 120 45 minus 120.

so if you check that amount that amount becomes less than uh 430 if it becomes

becomes less than uh 430 if it becomes less than 430 minutes this percentage

less than 430 minutes this percentage will go above more than 100 that's why

will go above more than 100 that's why you will see it's 181 percent

you will see it's 181 percent tax rate has to increase or fall for

tax rate has to increase or fall for sale The Net Present Value to fall to

sale The Net Present Value to fall to zero it has to increase so tax rate but

zero it has to increase so tax rate but because it's C whatever the cost cost

because it's C whatever the cost cost has to rise for Net Present Value to

has to rise for Net Present Value to fall down to zero if it's income like

fall down to zero if it's income like inflow inflow have to fall down

inflow inflow have to fall down so inflow has to fall down outflows to

so inflow has to fall down outflows to increase for Net Present Value to become

increase for Net Present Value to become zero this is common simple common sense

zero this is common simple common sense tax rate Will Rise by 181 then old days

tax rate Will Rise by 181 then old days so which situation is better tax rate

so which situation is better tax rate because it's very unlikely tax rate will

because it's very unlikely tax rate will increase that much 181 percent so that

increase that much 181 percent so that means it's safe

means it's safe from the tax raise point of view Net

from the tax raise point of view Net Present Value will not fall to zero very

Present Value will not fall to zero very unlikely but from the point of sales

unlikely but from the point of sales chances are there it's a little risky

chances are there it's a little risky not so risky 19.4 percent

not so risky 19.4 percent now discount rate

now discount rate discount rate is 10 percent

okay this cannot be calculated using the standard formula this you cannot

standard formula this you cannot calculate the discount rate

then how do you find the sensitivity to discount rate

discount rate you use irr

okay based on irr you can find out but anyway this thing you can just

but anyway this thing you can just ignore it because in the exam you don't

ignore it because in the exam you don't have to write about it but the other two

have to write about it but the other two variables you need and finally you need

variables you need and finally you need to interpret what could you interpret

you can say that because the project is giving a positive Net Present Value they

giving a positive Net Present Value they might be inclined to accept the project

might be inclined to accept the project correct this is how you need to write

correct this is how you need to write develop this way of writing hence

develop this way of writing hence project is positive they might accept

project is positive they might accept but or however use connecting words

but or however use connecting words before making a final decision take

before making a final decision take sensitivity into account

sensitivity into account needs to be considered

needs to be considered okay because small positive change in

okay because small positive change in estimates could have an impact on that

estimates could have an impact on that positive Net Present Value also could

positive Net Present Value also could become negative

become negative okay

okay so that's it now we are moving on to uh

so that's it now we are moving on to uh this modified sorry

this modified sorry Monte Carlo simulation

Monte Carlo simulation okay so we don't need to read all this

okay so we don't need to read all this we can just skip through okay

we can just skip through I will just take you through this so they have given

take you through this so they have given you different ranges of sales revenue

you different ranges of sales revenue and the cost with the probability okay

and the cost with the probability okay and they have assigned some random

and they have assigned some random numbers assume integers okay like this

numbers assume integers okay like this then

based on whatever they have done okay this is done in computer computers can

this is done in computer computers can do this much faster

do this much faster 382 okay so based on that they have

382 okay so based on that they have given some random numbers to this sales

given some random numbers to this sales revenue

revenue okay and this random numbers to this

okay and this random numbers to this cost and they have got the profit

you can just deduct your cost from sales revenue and get this profit

revenue and get this profit okay

[Music] so now easily you can see where the loss

so now easily you can see where the loss is being incurred here

so all these things is not so important for you whatever is written here that's

for you whatever is written here that's why I'm not reading it I can skip

why I'm not reading it I can skip through it

through it okay but one thing you can be sure the

okay but one thing you can be sure the simulation cannot give a definitive

simulation cannot give a definitive answer whether to undertake a project or

answer whether to undertake a project or not it just gives you a range of values

not it just gives you a range of values so that you can make your decision

so that you can make your decision better

better okay basically the risk where the loss

okay basically the risk where the loss is going to occur

is going to occur for example their status come making a

for example their status come making a loss here if you see that's 17 at 254

loss here if you see that's 17 at 254 and if this is the cost

but it's just giving a range of different different profits

different different profits 134 is very high whereas 146 is 46 the

134 is very high whereas 146 is 46 the lowest then we have loss so just giving

lowest then we have loss so just giving you some possible outcomes based on some

you some possible outcomes based on some random quotes that's it that's what

random quotes that's it that's what simulation is doing from the computer

simulation is doing from the computer other than that you cannot take one firm

other than that you cannot take one firm decision that you are going to accept

decision that you are going to accept the project or not that is a limitation

the project or not that is a limitation of simulation foreign

of simulation foreign [Music]

simulation looks like okay so this is regarding

okay so this is regarding two projects project a and Project B

two projects project a and Project B so they have used simulation to generate

so they have used simulation to generate a distribution of profits for each

a distribution of profits for each okay

okay number of times the profit occurs

number of times the profit occurs frequency you can see it's very high for

frequency you can see it's very high for a compared to B

a compared to B okay

okay now based on this which project should

now based on this which project should the business invest in

aob let's study one by one

let's study one by one start studying a if you see a mean is

start studying a if you see a mean is lower for a compared to B okay project a

lower for a compared to B okay project a has a lower average profit

has a lower average profit lower average profit but it's also less

lower average profit but it's also less risky because less variability of

risky because less variability of possible profits why how do you know

possible profits why how do you know that

that see the gap

see the gap it's less that means variability of

it's less that means variability of getting projects a is less and also it's

getting projects a is less and also it's uh it's in the positive

uh it's in the positive I mean it does not fall on the other

I mean it does not fall on the other side negative losses it does not go so

side negative losses it does not go so it's variability is

it's variability is variability if you want to see check the

variability if you want to see check the distance so less compared to BB is very

distance so less compared to BB is very wide

wide ly distributed so risk is less but

ly distributed so risk is less but average profit if you see it's low

okay coming to be p is the opposite of a it

coming to be p is the opposite of a it has a higher average profit but it's

has a higher average profit but it's also more risky because more variability

also more risky because more variability of possible professors there there is no

of possible professors there there is no correct answer in this case okay you can

correct answer in this case okay you can either choose a based on your but you

either choose a based on your but you need to justify okay

need to justify okay all simulation will do is give the

all simulation will do is give the business the above results now it's up

business the above results now it's up to you to take that decision they will

to you to take that decision they will not take a decision for you they will

not take a decision for you they will only give you the picture

only give you the picture it will never tell you which project is

it will never tell you which project is better it's up to you

better it's up to you if you are willing to take the risk you

if you are willing to take the risk you will go for project me if you're not

will go for project me if you're not willing to take the risk you will go for

willing to take the risk you will go for projected

okay but if you take low risk remember average returns are lower so it's a

average returns are lower so it's a decision a business needs to make

decision a business needs to make foreign

okay this measure is a measure of how market

this measure is a measure of how market value of an asset is likely to decrease

value of an asset is likely to decrease over a certain time

okay the holding period usually only 10 days under normal market conditions

days under normal market conditions definition and all you don't have to

definition and all you don't have to specifically know so much okay but just

specifically know so much okay but just no value at risk is the measure of a

no value at risk is the measure of a risk you can see right the word risk

risk you can see right the word risk itself says it's something to do with

itself says it's something to do with risk

risk and this is measured by using normal

and this is measured by using normal distribution Theory the calculation of

distribution Theory the calculation of this is very easy very simple very easy

this is very easy very simple very easy very straightforward you just have to

very straightforward you just have to know that that's it the calculation body

know that that's it the calculation body often okay

often okay so basically that means the amount at

so basically that means the amount at risk to below how much can you what is

risk to below how much can you what is the risk that you're going to lose an

the risk that you're going to lose an amount

amount under some conditions

under some conditions some holding period okay and this is

some holding period okay and this is particularly done at confidence level

particularly done at confidence level for example at 95 confidence level how

for example at 95 confidence level how much can you risk of losing at 99

much can you risk of losing at 99 confidence level how much do you risk of

confidence level how much do you risk of losing confidence level they will give

losing confidence level they will give you based on that what is the amount of

you based on that what is the amount of risk that you're going to lose something

risk that you're going to lose something that is the meaning of value at risk

that is the meaning of value at risk okay confidence levels are usually

okay confidence levels are usually usually at 95 or 90 if you see but

usually at 95 or 90 if you see but sometimes they can give you 90 also

sometimes they can give you 90 also okay

95 confidence level means what that means if you take it take it in terms of

means if you take it take it in terms of probability there's a five percent

probability there's a five percent chance of being losing something that is

chance of being losing something that is the meaning 95 convenient that is your

the meaning 95 convenient that is your 95 confident about not losing something

95 confident about not losing something that means five percent you will lose

that means five percent you will lose there is a chance of being lost right

there is a chance of being lost right the value address gives that amount only

the value address gives that amount only that there's a five percent chance of

that there's a five percent chance of losing this amount same for 99

losing this amount same for 99 confidence level

confidence level now let us do a small question before we

now let us do a small question before we summarize everything because we are over

summarize everything because we are over with this lecture that's that's it

with this lecture that's that's it before we

before we move on to our next lecture

test your understanding too okay here you need to calculate the value at risk

you need to calculate the value at risk and advise whether you have to take a

and advise whether you have to take a project or not okay let us see most of

project or not okay let us see most of the facts will be given to you you just

the facts will be given to you you just have to use the formula and calculate

have to use the formula and calculate that's it Net Present Value is 1 million

that's it Net Present Value is 1 million okay

okay standard deviation is 0.3 million see

standard deviation is 0.3 million see standard deviation you need okay

standard deviation you need okay standard deviation is the variability

standard deviation is the variability we have just seen a diagram right what

we have just seen a diagram right what is the variability

is the variability of the profit that's why we need

of the profit that's why we need standard deviation because value address

standard deviation because value address follows a normal distribution that graph

follows a normal distribution that graph and at 90 percent certainty that means

and at 90 percent certainty that means 90 confidence level

90 confidence level you need three things confidence level

you need three things confidence level standard deviation and the Net Present

standard deviation and the Net Present Value that's it to find the value at

Value that's it to find the value at risk now

risk now we are going to find the

we are going to find the at 90 confidence level we are going to

at 90 confidence level we are going to find the value at risk

find the value at risk okay

so if you go by the normal distribution table

there's a normal distribution table will be given to in exam this thing okay that

be given to in exam this thing okay that is also there

is also there at 90 confidence level okay so you can

at 90 confidence level okay so you can find the value from there

find the value from there we need to find

we need to find 0.4

0.4 in the normal distribution table this

in the normal distribution table this corresponds to 1.28 standard deviation

just wait a minute okay

therefore okay

therefore the annual value at risk and ninety percent is what

ninety percent is what you take 1.28

you take 1.28 this value you have to take

this value you have to take and multiply it with the standard

and multiply it with the standard deviation

deviation 1.2 is standard deviation is 1.28

1.2 is standard deviation is 1.28 multiplied by standard deviation okay

multiplied by standard deviation okay amount you have to get from the table

amount you have to get from the table okay

how do you get the table see at 90 minutes from 90 to 50 percent maybe they

minutes from 90 to 50 percent maybe they have given some range it is this value

have given some range it is this value so using this value 1.28 is the value

so using this value 1.28 is the value this is the make sure you get this value

this is the make sure you get this value by the way go to that table because you

by the way go to that table because you have to know how to read the table okay

have to know how to read the table okay just don't blindly take 1.28

just don't blindly take 1.28 because I cannot help you I have not

because I cannot help you I have not included that table here I should have

included that table here I should have done it but anyways you can go and check

done it but anyways you can go and check 1.28 into 0.3 this after getting this

1.28 into 0.3 this after getting this amount check the project is for one year

amount check the project is for one year or more than one year usually they will

or more than one year usually they will give you more than one year if it's more

give you more than one year if it's more than one year you have to take the

than one year you have to take the square root of the number of the year of

square root of the number of the year of the projected this is a five-year

the projected this is a five-year project that means square root of 5 if

project that means square root of 5 if it was for 4 years square root of 4 that

it was for 4 years square root of 4 that is 2.

is 2. this answer take it and multiply by

this answer take it and multiply by square root of number of years that is

square root of number of years that is five number of the years of the project

five number of the years of the project this one

this one okay what does it mean

okay what does it mean that means

that means there is a 90 sure that you are your Net

there is a 90 sure that you are your Net Present Value will not fall below this

Present Value will not fall below this amount 0.859

amount 0.859 okay

that was all the five year period we are not talking about single year over the

not talking about single year over the five-year period

five-year period so we can be sure that expect Net

so we can be sure that expect Net Present Value 1 million okay that means

Present Value 1 million okay that means we are going to get this much of Net

we are going to get this much of Net Present Value you can be sure of that 90

Present Value you can be sure of that 90 you can be sure

okay so so the actual networks and value will be at least at least this much

will be at least at least this much deducted this value at risk you need to

deducted this value at risk you need to deduct that value address from The Net

deduct that value address from The Net Present Value it's like a margin of

Present Value it's like a margin of safety or keeping at least it will be

safety or keeping at least it will be 0.141 90 you are sure of this but still

0.141 90 you are sure of this but still this is a positive Net Present Value

this is a positive Net Present Value that means the project should be

that means the project should be undertaken remember the question also

undertaken remember the question also asked you whether you should accept the

asked you whether you should accept the project or not yes you should because

project or not yes you should because still Net Present Value is positive

now we are going to summarize everything that we have covered in this lecture and

that we have covered in this lecture and make sure lecture one you start your a

make sure lecture one you start your a from the lecture one in fact start in

from the lecture one in fact start in this order Things become very easy okay

this order Things become very easy okay and lecture one

and lecture one is the easiest lecture you will come

is the easiest lecture you will come across in AFM because after this we are

across in AFM because after this we are going to move on to more developed

going to move on to more developed stages and also okay more complex issues

stages and also okay more complex issues and all which you might not have covered

and all which you might not have covered in financial management but this things

in financial management but this things whatever you have covered in lecture one

whatever you have covered in lecture one most of the things are covered in

most of the things are covered in financial management maybe some Advanced

financial management maybe some Advanced that's it

that's it so we have started with Net Present

so we have started with Net Present Value right with inflation with taxation

Value right with inflation with taxation positive net prison better accept

positive net prison better accept negative don't accept second we went

negative don't accept second we went through irr and mirror where we compared

through irr and mirror where we compared both

both okay and we told that irr is not the

okay and we told that irr is not the most suitable method compared to Net

most suitable method compared to Net Present Value and mirror

Present Value and mirror and mirr formula is there irr formulas

and mirr formula is there irr formulas the interpolation

the interpolation third

third we went through mccallo duration and

we went through mccallo duration and modified duration

modified duration which takes into account time value of

which takes into account time value of money okay for which formula is there

money okay for which formula is there fourth multi-period Capital resting only

fourth multi-period Capital resting only discuss where we went through a linear

discuss where we went through a linear programming and all but I think you

programming and all but I think you don't have to do linear programming from

don't have to do linear programming from this session onwards you just have to

this session onwards you just have to discuss

discuss but anyway if linear program is asked

but anyway if linear program is asked you will be able to do it because I've

you will be able to do it because I've explained it

explained it fifth

fifth Monte Carlo's emulation

Monte Carlo's emulation that it overcomes sensitivity analysis

that it overcomes sensitivity analysis problem it takes multiple variables and

problem it takes multiple variables and check but it does not give a definite

check but it does not give a definite answer it just gives you a range of

answer it just gives you a range of answer you need to decide based on the

answer you need to decide based on the risk that are you willing to take it or

risk that are you willing to take it or not

not then we've finished it with the value at

then we've finished it with the value at risk usually at 99 and 95 confidence

risk usually at 99 and 95 confidence level okay

level okay but it could be a different number also

but it could be a different number also even if it's a different number you can

even if it's a different number you can still find it out from the normal

still find it out from the normal distribution table okay table will be

distribution table okay table will be provided to you so that's it for lecture

provided to you so that's it for lecture one on AFM I hope that you like this and

one on AFM I hope that you like this and you found it very valuable and helpful

you found it very valuable and helpful if you did so please let me know through

if you did so please let me know through you can comment me you can email me and

you can comment me you can email me and do share this with your friends who does

do share this with your friends who does not know that the AFM is available again

not know that the AFM is available again okay

so thank you for watching and see you in lecture 2 in the lecture today we are

lecture 2 in the lecture today we are going to cover real options

going to cover real options which is Again part of Net Present Value

which is Again part of Net Present Value which will again come on the Net Present

which will again come on the Net Present Value it will become so we at the end we

Value it will become so we at the end we are going to combine this too okay

are going to combine this too okay so till then thank you for watching and

so till then thank you for watching and do subscribe to my channel if you

do subscribe to my channel if you haven't subscribed yet

haven't subscribed yet see you

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YouTube Transcript:ACCA I Advanced Financial Management (AFM) I Discounted Cash Flow Techniques - AFM Lecture 1

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ACCA I Advanced Financial Management (AFM) I Discounted Cash Flow Techniques - AFM Lecture 1