Question
Explain the discounted measures of project worth using hypothetical data.
Answer :
Word Count : 1065
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Discounted measures of project worth are essential tools in project analysis because they recognize the time value of money. The fundamental principle underlying these measures is that a rupee received today is worth more than a rupee received in the future due to its earning capacity. Therefore, future costs and benefits must be converted into their present values using an appropriate discount rate. The most commonly used discounted measures of project worth are Net Present Value (NPV), Benefit-Cost Ratio (BCR), and Internal Rate of Return (IRR). These techniques help decision-makers evaluate whether a project is financially viable and compare alternative investment opportunities. Net Present Value is the difference between the present value of cash inflows and the present value of cash outflows over the life of a project. It is calculated by discounting each year’s net cash flow to its present value using a chosen discount rate, often referred to as the cost of capital or required rate of return. Suppose a project requires an initial investment of ₹1,00,000 and is expected to generate net cash inflows of ₹30,000 per year for five years. If the discount rate is 10 percent, the present value of each year’s cash inflow is calculated using the formula PV = Cash Flow / (1 + r)^n, where r is the discount rate and n is the year. For Year 1, the present value is ₹30,000 / 1.10 = ₹27,273. For Year 2, it is ₹30,000 / (1.10)^2 = ₹24,793. For Year 3, it is ₹30,000 / (1.10)^3 = ₹22,539. For Year 4, it is ₹30,000 / (1.10)^4 = ₹20,490. For Year 5, it is ₹30,000 / (1.10)^5 = ₹18,627. The total present value of inflows equals ₹1,13,722. The initial investment of ₹1,00,000 is already at present value since it occurs at Year 0. Therefore, NPV = ₹1,13,722 – ₹1,00,000 = ₹13,722. Since the NPV is positive, the project is considered acceptable because it adds value to the firm. If NPV were negative, the project would be rejected, and if it were zero, the project would be indifferent as it just earns the required rate of return. The Benefit-Cost Ratio, also known as the Profitability Index, is another discounted measure that expresses the relationship between the present value of benefits and the present value of costs. It is calculated as BCR = Present Value of Benefits / Present Value of Costs. Using the same example, the present value of benefits is ₹1,13,722 and the present value of costs is ₹1,00,000. Therefore, BCR = 1,13,722 / 1,00,000 = 1.137. Since the ratio
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