Batliboi is considering the building of a new toll bridge. In return for financing the bridge, the company is entitled to receive all of the toll revenues generated in each of years 3 to 5. If the bridge is a success and proves popular with travelers, then toll revenues are estimated to be within the range of 40-50 pa. If it is not popular, then revenues will instead be within the range of 20-30 pa. The cost of building the bridge is estimated to be 50, and if the weather remains fine, it will be completed within one year. Bad weather will cause construction to drag on into year two, when an additional cost of 20 will be incurred. Finally, company also faces the risk of possible strike action by the workforce. If a strike occurs, it will increase the costs incurred in each year of construction by 20%. Assuming that : The probability that the bridge is a success is 2/3 The probability of bad weather is 1/2 The probability of a strike is also ½ if weather is good, but only ¼ if the weather is bad All cash- flows are assumed to arise at the start of each year Calculate the expected NPV of the project using a discount rate of 10 % and comment on your results. Note: All figures are in Rs. Crore just cant get the calculations right...help required..at the earliest...($O$)
Its easy. Just dont mix up since there is lot of data. Think of combinations of all events that can happen. For instance - If bridge is a success, no strikes, good weather Then the cashflows will be -50,0,45,45,45. Find the NPV for these cashflows. Probability will be 2/3*1/2*1/2 = 1/6. Then multiply the NPV with the probability. It says that the probability of getting that NPV is 1/6. Do this for all the possible scenarios. You should get 8 scenarios. Lastly to cross-check add up all the probabilities to see that you get 1.
c...i got this probability stuff...but m not able to get the NPV right.....m getting an amt either higher or lower...but not the ans....can u pls elaborate the calculations of NPV
It's not reasonable to expect others to all the calculations for you. You haven't shown any of your own calculations or even told us what answer you are aiming for. Perhaps if you explain clearly what you are getting stuck on you will get the answers you are looking for.
i tried discounting the cash flows @10% i/e..-50*.9090+0+45*7513+45*.6830+45*6292=47.034....which is different from the solution given. This happens again when the state of world changes, the ans differs.... Overall the total ans changes altogether giving a different view of the problem.... Now this is the method which has to be follwed...as in my view...just confirm my method n approach
Hey sorry. I was preparing for the other exam. Couldnt reply. Your method is right. Only 1 small mistake. The questions says "All cashflows arise at the beginning of the year" So its -50 + 0(1.1) + 45(1.1^2) + 45(1.1^3) + 45(1.1^4) = 51.73. You might have done the same mistake with all the scenarios.
eureka.....thanks a lot.....got it perfect....i knew from the start of the sum that negative cashflows arent discounted......but still made that mistake.....one more silly question...but in the question..it is clearly mentioned that -50 occurs in the first year.....so y do we start discounting 0 @ 10% taking n=1....
Technique to compute PV Hi ! You made a statement 'i knew from the start of the sum that negative cashflows arent discounted.....'. This may not be hold under all circumstances. There could be negative cash-flows later on which needs to be discounted. There is something I learnt when I studied this paper. May turn out to be useful to you as well. While solving such questions, do the following: 1. Draw a time line and mark time points (k) from 0 to last time point where a cash-flow occurs 2. Write down all +ves and -ves cash-flows below each time point. Like if the question says 'all cash-flow occurs at start of year', place all cash-flows at start of each interval. 3. Place discount factors (v^k) above each time point 4. Multiply the cash-flows with the corresponding discount factors and then add them up. You get your PV. Note this will work even in cases where cash-flows occur multiple times within one year time period say monthly or quarterly. You can use this technique when you are asked to compute accumulated value as well. If you can do this every-time, you will never make a mistake.
I think you misinterpreted my answer (or maybe I think so). All cashflows (negative or positive) are discounted. But they say that all cashflows occur at the beginning of the year. -50 occurs in the beginning of the first year, so at that point n=0. The 2nd cashflow "zero" occured at the beginning of the 2nd year which is approximately equal to occurring at the end of the 1st year. Hence n=1. Hope its clear to you. When they say that cashflows occur at the beginning, you start at n=0. Its like asking, what is the present value of the investment you made today? Get it?
thanks a lot kartik n bapan...very useful suggestions.....sorted out all my doubts regarding the NPV method....thanks a lot....
