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< Answer
1. The dividend per share and the price per share data of AFX Ltd. are given below: >
Year 1 2 3 4
Dividend per share Rs.5.00 Rs.6.20 Rs.7.25 Rs.6.75
Current market price Rs.900 Rs.975 Rs.1150 Rs.1250
The
realized yield over the first three year period is
(a) 10.36% (b) 11.63% (c) 12.24% (d) 14.44% (e) 14.96%.
< Answer
2. Mr. Suresh wants to invest in a particular project involving laying of 120 km of optical fibre. The >
probability distribution of the outcome is as follows:
END OF SECTION A
Section B : Problems (50 Marks)
• • This section consists of questions with serial number 1 – 5.
• • Answer all questions.
• • Marks are indicated against each question.
• • Detailed workings should form part of your answer.
• • Do not spend more than 110 - 120 minutes on Section B.
1. A textile company produces two types of materials - A and B. The material A is produced according to direct
orders from furniture manufacturers. The material B is distributed to retail fabric stores. The average production
rates for the materials A and B are identical – 1,000 metres per hour. By running two shifts the operational capacity
of the plant is 80 hours per week.
The marketing department reports that the maximum estimated sales for the following week is 70,000 metres of
material A and 45,000 metres of material B. According to the accounting department, the profit from a metre of
material A is Rs.2.50 and from a metre of material B is Rs.1.50.
The management of the company decides that a stable employment level is a primary goal for the firm. Therefore,
whenever there is demand exceeding normal production capacity, management simply expands production
capacity by providing overtime. However, management feels that overtime operation of the plant of more than 10
hours per week should be avoided because of the accelerating costs. The management has the following goals in
order of their importance.
P1 : Avoid any underutilization of production capacity.
P2 : Limit the overtime allowed for plant operation to 10 hours per week.
P3 : Achieve the sales target of 70,000 metres of material A and 45,000 metres of material B.
P4 : Minimize overtime operation of the plant as much as possible.
Formulate this problem as a goal programming model.
(12 marks) < Answer >
2. A small marketing project consists of number of activities. Normal time (in days), a minimum or crash time (in
days) and the cost (in Rs. per day) of crashing each activity is as follows:
Normal duration Minimum crash Cost of crashing
Activity
(days) duration (days) (Rs. per day)
1–2 9 6 20
1–3 8 5 25
1–4 15 10 30
2–4 5 3 10
3–4 10 6 15
4–5 2 1 40 You are required to
a. Find out the normal project length and the minimum project length.
b. Determine the minimum crashing cost of schedules ranging from normal length down to, and including the
minimum length schedule, i.e., if L is the length of the normal schedule, find the cost of schedules which are
L, L – 1, L – 2, and so on days long. If overhead cost total is Rs.60 per day, what is the optimal length
schedule duration on each activity for optimal solution?
(4 + 6 = 10 marks) < Answer >
3. Envestnet Ltd. is evaluating an investment proposal which has uncertainty associated with the three important
aspects: the original cost, the useful life, and the annual net cash flows. The three probability distribution for these
variables are shown below:
Original cost Useful life Annual net cash inflows
Value Probability Period Probability Value Probability
Rs.60,000 0.3 5 years 0.4 Rs.10,000 0.1
Rs.70,000 0.6 6 years 0.4 Rs.15,000 0.3
Rs.90,000 0.1 7 years 0.2 Rs.20,000 0.4
Rs.25,000 0.2 The firm
wants to perform five simulation runs of its project’s life. The firm’s cost of capital is 15% p.a. and the risk-free
rate is 6% p.a.; for simplicity it is assumed that these two values are known for certain and will remain constant
over the life of the project.
You are required to simulate the probability distributions of original cost, useful life and annual net cash inflows,
using the following sets of random numbers:
09, 84, 41, 92, 65; 24, 38, 73, 07, 04; and 07, 48, 57, 64, 72 respectively each of the five simulations runs.
(10 marks) < Answer >
4. Viswa Lamps Ltd. (VLL) is in the business of specialty lamps for factory illumination. Most of its products are
made in its own factory while some are outsourced. Currently the company wants to introduce a new Lamp for
railway sheds, which can be made in its factory or bought from its suppliers.
If VLL wants to produce the Lamp it requires an investment of Rs.20,00,000 in plant and machinery, which can be
fully depreciated on a straight-line basis over its useful life of 10 years. The cost of production (excluding
depreciation) per Lamp is expected to be Rs. 82. A supplier is quoting a price of Rs.90 per Lamp and is ready to
supply any quantity at the same price. The company’s cost of capital is 12% and the tax rate is 30%. Assume all
cash flows are certain.
You are required to
a. Advise the company (with detailed working notes) whether to Make or Buy the Lamps if the market demand
is for 50,000 Lamps per annum.
b. Compute the minimum annual demand (quantity) so that the company can produce on its own and the NPV is
not negative.
(4 + 4 = 8 marks) < Answer >
5. Mukherjee Polymers Ltd.(MPL) is considering an expansion project for which it proposes to employ debt-equity
ratio of 2:1. Its pre-tax cost of debt will be 15% p.a. and its expected tax rate is 30%. The incremental cash flows
from the project is given below:
Year Cash flows (Rs. crore)
0 –1,600
1 10,000
2 –10,000 The equity-betas and debt-equity ratios of three companies engaged
in the same industry are given below:
Company Equity-beta Debt-equity ratio
Reliable 1.40 2.25
Essel 1.10 1.80
Marvel 1.05 2.00 The risk-free rate is 8% p.a. and the expected return
on market portfolio is 12% p.a..
You are required to
a. Find out the required rate of return on the expansion project.
b. Appraise the expansion project based on IRR.
(5 + 5 = 10 marks) < Answer >
END OF SECTION B
6. Best Projects Ltd. is considering alternate methods of appraising its capital expenditures, especially in view of the
various expansion slated for the future. The finance manager of the firm argues in favour of Net Present Value
criterion much against the ideologies of the Vice-President. In this context, how should the finance manager
convince the VP that the NPV leads to better investment decisions?
(10 marks) < Answer >
7. Projects are executed by the dynamic organizations. They use various skills and knowledge from the people
around. The project teams are not static groups, rather they consist of shuffling lot from different levels of the
organization. This type of collaboration calls for successful team building. Discuss the various features of a
program for successful team building.
(10 marks) < Answer >
END OF SECTION C
Suggested Answers
Project Management-I (241) : April 2006
Section A : Basic Concepts
1. Answer : (c) <
TO
D n Pn P>
Pn 1
Reason : Wealth Ratio =
Therefore, Wealth Ratio :
Year 1 2 3
Wealth Ratio 1.09 1.19 1.09
The geometric average return (yield) over the three year period is :
1
(1.09 1.19 1.09) 3 1 12.24%
Hence, option (c) is the correct answer.
2. Answer : (b) <
Reason :Range R h R l 900 200 Rs.700Lac
TO
P>
MAD i i
p R R 0.2(360) 0.5(60) 0.30(340) Rs.204 Lac
160
1− = 0.60
or ACWP
160 160
ACWP = = = 400
(1 − 0.60) 0.40
or
Hence option (b) is the correct alternative.
12 Answer : (d) <
TO
. Reason :Total float = LOTB - (EOTA + dAB) = 28 – (14+8) = 6 P>
Where ( R i − R ) < 0
Here expected NPV = 0.20 × 75 + 0.45 × 45 + 0.35 × 30 =
45.75.
∴ Semi – variance = [0.45 (45 – 45.75)2 + 0.35 × (30 – 45.75)2]
= 0.253 + 86.822
= 87.075 ≅ 87.08.
Hence option (c) is the correct alternative.
15 Answer : (c) <
TO
. Reason :Principal loan amount = Rs.200 lakhs or Rs.20 million. P>
approach of social cost Benefit Analysis (SCBA), there are also differences
between both the approaches. Some of the dissimilarities are:
− − L & M approach measures costs and benefits in terms of
international prices (border prices) where as UNIDO approach
measures costs and benefits in terms of domestic rupees.
− − L & M approach measures costs and benefits in terms of
uncommitted social income where as the UNIDO approach measures
costs and benefits in terms of consumption.
So the alternative (d) is the answer.
17 Answer : (a) <
TO
. Reason : P>
Activity to tm tp te σ
1
1–2 1.0 2.0 3.0 2.0
3
1
2–3 1.0 1.5 2.5 1.58
4
5
1–3 1.5 4.0 6.5 4
6
3−4
Pz≤
Probability (t ≤ 3) = 5/6
−6
Pz≤
= 5
= ( ) = 11.51%.
P z ≤ − 1.2
As asset beta is unchanged and D/E has increased so equity beta would
definitely increase. Alternative (b) is the answer. Automatically other
alternatives stand as incorrect.
19 Answer : (d) <
TO
. Reason :Let say terminal value of the cash inflows are x then modified NPV. P>
x
− 1000
(1.12)10
=
x
− 1000
(1.12)10
or 400 =
or x = 1400 × 1.1210
= 4348.19.
Let the modified IRR be r
Ter min al value
Initial outlay
∴ (1 + r) 10
=
1/ 10
4348.19
1000.00 −1
or r =
= 1.158 – 1
= 0.158.
∴ Modified IRR = 15.8%.
Hence option (d) is the correct alternative.
20 Answer : (e) <
TO
. Reason :The various situations and its corresponding term in the objective function P>
price strategy is useful and the price that should be fixed to win the contract
should be quite low.
Therefore, option (c) is the correct answer.
24 Answer : (b) <
TO
. Reason : If project R cannot be accepted unless at least two projects from the projects. P, Q, S and T P>
are accepted then the corresponding project interdependency constraint can be represented
as
2XR ≤ XP + XQ + XS + XT
the management.
Sales Constraint. Since the maximum sales for the following week is 70,000 metres of material
A and 45,000 metres of B, the sales constraint is
x1 d 2 70, 000 and x 3 d 3 45, 000
Where d 2 and d 3 are the underachievement of sales target of materials A and B respectively.
Overtime Constraint. The overtime constraint is
d1 d 4 d 4 10,
Where d 4 = amount of underutilized hours between the actual overtime allowed and 10
hours of overtime, and d 4 = amount of overtime in excess of the allowed 10 hours.
Both negative and positive deviations are included from the allowed 10 hours of overtime,
because the actual overtime can be less than, equal to, or even more than 10 hours.
Substituting the value of d1 in the production hours constraint, we get
x1 x 2 d 4 d 4 90,
Achievement Function. Since sales goals for materials for equally important, the profit
contribution ratio (5:3) between these two will be considered as different weights. The
achievement function, therefore, is:
Minimize z = P1d1 P2 d 4 5P3 d 2 3P3 d 3 P4 d1
The complete goal programming problem, therefore, is as under:
Minimize z = P1d1 5P3d 2 3P3 d3 P2 d 4 P4 d1
subject to the constraints: x1 x 2 d1 d1 80
x1 x 2 d 4 d 4 90,
x1 d 2 70000, and x 2 d 3 45000
x1 , x 2 , d1 , d1 , d 2 , d 3 , d 4 , d 4 0
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2. a. Considering the normal duration of the project, the resulting network is given below:
The critical path comprises the activities (1, 3), (3, 4) and (4, 5) with the normal duration
of time as 20 days and the minimum project length is 12 days.
b. Since the present schedule involves more time, we shorten the duration by crashing some
of the activities. As the activities lying on the critical path control the project duration, we
shorten the duration of some activities lying on the critical path.
Following table gives the project duration with crashing cost and total cost:
Activities Project Crashing cost Overhead Total
cost cost
crashed duration (Rs.) Rs.60 per (Rs.)
day
– 20 Nil 20 × 60 1,200
3–4 19 15 = 15 19 × 60 1,155
3–4 18 15 + 15 = 30 18 × 60 1,110
3–4 17 30 + 15 = 45 17 × 60 1,065
1 – 4, 3 – 4 16 45 + 30 + 15 = 16 × 60 1,050
90
4–5 15 90 + 40 = 130 15 × 60 1,030
1 – 3, 1 – 4, 2 – 4 14 130 + 65 = 195 14 × 60 1,035
1 – 3, 1 – 4, 2 – 4 13 195 + 65 = 260 13 × 60 1,040
1 – 3, 1 – 4, 1 – 2 12 260 + 75 = 335 12 × 60 1,055 Since
the minimum total cost occurs for 15 days of duration, the optimum length of schedule is
15 days.
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3. To simulate the probability distributions corresponding to original cost, useful life and annual
net cash inflows, we assign an appropriate set of random numbers as shown below:
ORIGINAL COST
Value Probability Cumulative Random
(Rs.) probability number
60,000 0.3 0.3 00 – 29
70,000 0.6 0.9 30 – 89
90,000 0.1 1.0 90 – 99
USEFUL LIFE
Period Probability Cumulative Random
probability number
5 years 0.4 0.4 00 – 39
6 years 0.4 0.8 40 – 79
7 years 0.2 1.0 80 – 99
NET CASH INFLOWS
Value Probability Cumulative Random
(Rs.) probability number
10,000 0.1 0.1 00 – 09
15,000 0.3 0.4 10 – 39
20,000 0.4 0.8 40 – 79
25,000 0.2 1.0 80 – 99 The five simulation runs are now
performed and the results are tabulated below:
Original cost Useful life Annual net cash inflow
Simulation
run Random Random Random
Value (Rs.) Period (years) Value (Rs.)
number number number
1 09 60,000 24 5 07 10,000
2 84 70,000 38 5 48 20,000
3 41 70,000 73 6 57 20,000
4 92 90,000 07 5 64 20,000
5 65 70,000 04 5 72 20,000
Now let us
calculate NPV and payback period for run 1 to run 5. The risk-free rate is given to be 6%. Thus, the discounting
rate is taken to be 6% assuming that the required rate of return is 6% for the risk-free investment projects of the
company:
Run one Run two
Period (t)
Cash flow PVIF(6%,n) (2) × (3) Cash flow (3) × (5)
(1) (2) (3) (4) (5) (6)
0 –60,000 1.000 –60,000 –70,000 –70,000
1 10,000 0.9434 9,434 20,000 18,868
2 10,000 0.8900 8,900 20,000 17,800
3 10,000 0.8396 8,396 20,000 16,792
4 10,000 0.7921 7,921 20,000 15,842
5 10,000 0.7473 7,473 20,000 14,946
6 0.7050 42,124 84,248
NPV = (Rs.17,876) NPV = Rs.14,248
Payback period will exceed 5 Payback period = 4.05 years
years
E
1 D / E (1 t )
5. a. Asset beta of Reliable =
1.40
1 2.25(1 0.30)
= = 0.5437
1.10
Asset beta of Essel = 1 1.80 0.70 = 0.4867
1.05
Asset beta of Marvel = 1 2.00 0.70 = 0.4375
0.5437 + 0.4867 + 0.4375
∴ Average asset beta = 3 = 0.4893
D
β A 1 + (1 − t )
∴ Equity beta of MPL = E = 0.4893 [1 + 2.00 (1 – 0.30)] = 1.17
∴ Expected rate of return on equity = 0.08 + 1.17 (0.12 – 0.08) = 12.68%
2 1
×15(1 − 0.30) + ×12.68
∴ Required rate of return on the project or WACC = 3 3 = 7 + 4.23 =
11.23%
b. IRR is given by ‘r’ in the following equation:
10,000 10,000
−
(1 + r ) (1 + r ) 2
0 = –1600 +
10,000 10,000
−
or, 0 = –1600 +
x x2 [Replacing (1+r) by x]
or, 1600x2 – 10,000x + 10,000 = 0
7. An autonomous, aligned, mutually accountable, and enthusiastic team, in which diversity is cherished and mutual
trust is deep, can conquer worlds.
You cannot manufacture extraordinary team performance merely by designing the right structure, selecting the
right people, providing the right vision and reward, and facilitating the right work processes. All these are very
helpful but to achieve peak team performance you must develop rich, intimate and emotional relationships
between skilled people who trust one another and who enjoy spending time with one another.
Working relationships seem to work best when they are more family-like and less formal. Understanding, trust,
and co-operation gets developed when closeness is high, communication is informal and frequent, interpersonal
context is rich, and the scope for collaboration is unlimited.
Don’t overlook the intangibles, such as team culture, language, and ritual. They help create team identity, establish
a sense of order, build team spirit, release tension, and cope with pressures of time and uncertainty.
Don’t ignore space and neighbourhood management. Teams must spend a lot of time together, especially at the
beginning. The chances are considerably better as geographic proximity allows people to come together to
appreciate and like each other.
If possible select people with a sense of humour and the ability to smile. Attempt to ensure that the team is serious
about its work, but not overly so. Humour helps the team maintain its sanity and cope with the continuous stress of
project life – ‘laughter is the best medicine’. In successful teams, fun both sustains and gets sustained by team
achievements. Teamwork helps restore small conflicts before they escalate and enables swift response when
problems arise. Successful leaders know that often the only way to achieve ambitious project objectives is by
challenging some of the bureaucratic rules. Competent project leaders view the project as boundaryless to cope
better with changes brought by outsiders (customers, contractors, suppliers) into the project. This fosters outsiders
commitment to the project and facilitate their responsiveness towards change.
Synergy is the result of complementary team skills coupled with strong and meaningful interpersonal
relationships. Such a team is more insightful and intelligent than the sum of its individuals, and has a great
potential for continued collaborative learning. Commitment to each other, coupled with project commitment, gives
a powerful meaning to the team. Team energy and enthusiasm cannot be mandated from higher echelons. High
levels of team energy and enthusiasm are derived from and sustained by the creating challenging opportunities,
and by expecting and enabling the team members to work at their crest of capabilities. Ensure that team members
are constantly aware of the meaningfulness of their effort. Explain why and for whom the project is carried out,
and emphasise its significant contribution to the company or to society. Dedicated teamwork does not require the
ultimate sublimation of the individual. On the contrary, as a leader you should empower team members to be
constantly at their peak by giving them the necessary discretion and autonomy to make things happen. Power is an
expandable pie. Sharing power and responsibility results in more committed and accountable team members.
Project leaders who delegate power gain more power in turn. If you are having fun, you are not working! This
philosophy is absolutely wrong. Look for the many natural opportunities to celebrate team accomplishments and
hard effort. Use these events to give members the high visibility and special recognition they have earned. Genuine
leaders manage by personal example. They understand the power of their most inconsequential actions and are not
afraid to be water-carriers for their people.
Inspirational leaders have a transforming effect on themselves and their followers. They raise both to higher levels
to human conduct. Through their planning, implementation, and showing the way, leaders help team members
change their conception of expanding takes and get them to believe they ‘should, and can do it.’
Successful projects are managed by excellent teams that are led by good leaders.
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