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Estimating IRR through fake payback period method

JIMS C-702 Ankur Wahal

Technique
1. Calculate average annual cash inflow to assume fake annuity 2. Determine the fake payback period by dividing the project cost with the assumed annuity 3. Look for factor in Table A-4, the present value of Annuity 4. Look for the value closest to the fake payback period value in the same manner as in the case of annuity (i.e. at the given period) 5. The percentage given at the period equal to the fake payback period value should be the proxy IRR 6. Rule: If the initial period cash flows are less than the fake annuity, then the IRR will be equal or lower than the IRR arrived in 5 7. Rule: If the initial period cash flows are more than the fake annuity, then the IRR will be equal or higher than the IRR arrived in 5 8. Calculate the NPV based on the fake IRR 9. If the NPV is close to zero, than the IRR is computed, otherwise you could assume higher or lower percentage IRR computed in 5

Problem 1
ABC Ltd whose Kc is 10% is looking at the following two mutually exclusive projects
Year 0 1 2 3 4 5 Total Project Cost 70,000 10,000 20,000 30,000 45,000 60,000 1,65,000 50,000 40,000 20,000 10,000 10,000 1,30,000 Project X Project Y

Problem 2
One Project of XYZ Ltd is doing poorly and is considered for replacement. The following three mutually exclusive projects with project cost of 2,00,000 are considered, which one will you propose:
Year 0 1 2 3 4 5 Project Cost 200,000 50,000 50,000 50,000 55,000 1,90,000 80,000 80,000 80,000 30,000 1,00,000 1,00,000 10,000 Project A Project B Project C

Problem 3
ABC ltd is planning to purchase a machinery to meet increased demand. The cost of machinery is 50,000. The expected life of machinery is 5 years with SLM as depreciation. The Net Profit for 5 years is 5,000 per year. The After tax required rate of return for the company is 12% Calculate IRR

Problem 4
Project value 100 cr. Equity 15% and debt 85% Capex 4 installments 250 cr. at the end of each year in periods 1-4 Working Capital requirement is 3% of the Project Cost and bears an interest of 7% The debt of 85% is further divided into the following structure: Senior Debt 75% with repayments in 10 years and interest rate of 7% Subordinate Debt 10% with repayments in 5 years and interest rate of 12% The Project will generate steady Profits of 14 cr. for the project life Prepare the FCFE available for the equity shareholders

Problem 5
A project whose value is 200 cr. starts operations at T0. The Term Loan Project is 100 cr. 5% fixed rate is amortized in constant Principal repayment of 5 years. Tax rate is 30%. Calculate: Net income and cash flows for the sponsors in the 5 years of operating life, considering that the first 5 years of Project will generate EBITDA of 7.5 cr p.a. Calculate the IRR.

Problem 6
The revenue and operating costs for a Project of 4000 cr are given below:

0 Rev Op costs

1 1125 175

2 1175 175

3 1225 175

4 840 175

5 855 175

6 865 175

7 885 175

8 895 175

9 925 175

10 925 175

The depreciation schedule is as follows:


0 Dep 1 20% 2 20% 3 20% 4 10% 5 10% 6 10% 7 10%

Debt Equity ratio is 80:20, with debt repayment is equated for 10 years with bearing base interest rate of 7% with 3% spread. The tax rate is 33%

Prepare the income statement and the cash flows and calculate the IRRs

Problem 7
A Special Purpose Vehicle starts in T0 a 5,000 cr. project, financed with a D/E ratio of 1:1. Interest rate on the loan is floating rate but swapped against a 10% fixed interest rate. The schedule of payments during construction is the following:

Year 0 Year 1 Year 2 Year 3

10% 25% 40% 25% 100%

Every payment during the construction period is financed based on the agreed D/E ratio. The amortization of the outstanding loan at the end of year 3 starts at the end of year 4 and will be completed at the end of year 8 according to the following percentages of principal repayment:

Year End
Based on the information provided, calculate: 1. the outstanding amount of the loan at the end of year 3; 2. the amortizing schedule of the loan during the period 4-8 Assuming from the operating year the company generates a steady cash flow of about 1000 cr. For next 5 years. Then Calculate the IRR.

4 5 6 7 8

15% 15% 20% 20% 30% 100%