Question Paper Project Management - I (241) : April 2006 Section A : Basic Concepts (30 Marks)
1.
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This section consists of questions with serial number 1 - 30.
• • • •
Answer all questions. Each question carries one mark.
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Maximum time for answering Section A is 30 Minutes.
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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% 2.
(b) 11.63%
(c) 12.24%
(d) 14.44%
(e) 14.96%.
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: Outcome (Rs. in lakh)
Probability
900
0.20
600
0.50
200
0.30
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The variability measures that have been calculated by Mr. Suresh i.e., range and mean absolute deviation for the project are (a) (b) (c) (d) (e) 3.
Rs.400 lakh and Rs.204 lakh respectively Rs.700 lakh and Rs.204 lakh respectively Rs.700 lakh and Rs.240 lakh respectively Rs.300 lakh and Rs.540 lakh respectively Rs.300 lakh and Rs.700 lakh respectively.
Which of the following statements is false about the top-down budgeting?
< Answer >
(a)
Under this method, the procedure starts with an estimate of the cost of the project which is broken down into the cost estimate for smaller and smaller activities at each organization level (b) The basic assumption underlying this method is that employees at the lower levels of the organization tend to overstate both the resource and the time required to complete the project, either to keep sufficient margin for comfort or due to lack of knowledge, or both (c) Estimates are made in terms of machine hours and man-hours and are then converted into rupees by applying appropriate conversion factors (d) This method shows lack of confidence and feeling of loss of power from the point of view of top management (e) For companies that lay down their capital expenditure as, say, a percentage of the total revenue, it is easy to keep expenditure within the limit. 4.
‘If cash flows are perfectly correlated, the behavior of cash flows in all periods is alike’. Which of the following statements is/are true with reference to the above statement? I.
If actual cash flow in one year is α standard deviation to the left of its expected value, cash flows
< Answer >
in other years will also be α standard deviation to the left of their respective expected values. II. Cash flows of all years are linearly related to one another. III. Perfectly correlated cash flows can also be evaluated with the help of a series of conditional probability distributions. (a) Only (I) above (c) Both (II) and (III) above (e) All (I), (II) and (III) above. 5.
(b) Only (II) above (d) Both (I) and (II) above
Monte Carlo Simulation, when applied to study project risk, helps in generating a simulated probability distribution of net present value or any other criterion of merit. With reference to Monte Carlo Simulation, which of the following is not true?
< Answer >
(a)
It cannot handle problems characterized by numerous exogenous variables following any kind of distribution, complex interrelationships among parameters, exogenous variables, and endogenous variables (b) The process is inherently imprecise, i.e. it provides a rough approximation of the probability distribution of net present value (c) It is difficult for the decision maker to build a realistic simulation model due to its complexity (d) To determine the net present value in a simulation run, the risk free discount rate is used (e) It compels the decision maker to explicitly consider the interdependencies and uncertainties characterizing a project. 6.
Shadow wage rate is an important element in social cost benefit analysis. It is a function of one or more factors. Which of the following factors is/are not included in the function?
< Answer >
I. The cost associated with urbanisation. II. The marginal productivity of labour. III. The cost of having an additional amount committed to consumption when the consumption of worker increases as a result of the higher income he enjoys in urban employment. IV. Marginal cost and marginal cost benefit. (a) Only (II) above (d) (I), (II) and (III) above 7.
(b) Only (III) above (c) Only (IV) above (e) (I), (II)and (IV) above.
(a) Exponential Smoothing Method (c) Econometric Method (e) End use Method. 8.
(b) Chain Ratio Method (d) Delphi Method
The cost of investment required to install a cordless phone manufacturing set up is Rs.2 crore. The output is 1,00,000 units. If the capacity cost factor is 0.6, what will be the investment cost for 2,00,000 units? (a) Rs.2.40 crore (d) Rs.3.33 crore
9.
< Answer >
Which of the following is a qualitative method of demand forecasting?
(b) Rs.2.80 crore (e) Rs.1.32 crore.
< Answer >
(c) Rs.3.03 crore
Following are the details of domestic and international prices of the inputs and outputs of a project:
< Answer >
Particulars
Domestic Prices
World Prices
Inputs Raw Material
500
450
Consumable Stores
650
525
1,15 0
975
150
-
50
-
Administrative Overheads
200
-
Selling Expenses
100
-
500
-
1,65 0
-
Non-Tradable Inputs: Power, fuel & water Repairs & Maintenance
Total Input Costs Sales Realization per unit
2,00 1,200 0 The Effective Rate of Protection and the Domestic Resource Cost, if the exchange rate per US Dollar is Rs.46, are respectively (a) 0.26 and 71.56 (d) 0.76 and 71.56
(b) 0.56 and 71.56 (e) 0.76 and 91.56.
(c) 0.56 and 91.56
10. Hyper Power Corporation Ltd. set-up a thermal power plant at a cost of Rs.500 crore in the previous year. Cash inflow from this power plant in the current year is Rs.80 crore and this is expected to increase by 20% for the next year. The company is planning to abandon this project at the end of next year. What would be the minimum acceptable abandonment value of this plant to the company?
< Answer >
(The opportunity cost of capital for the company is 12%) (a) Rs.324.0 crore (d) Rs.441.6 crore 11.
(b) Rs.352.0 crore (e) Rs.473.9 crore.
(c) Rs.395.1 crore
One of the highway projects is suffering from high time and cost overruns. Cost and schedule variances pertaining to this project are Rs.160 crore (A) and Rs.250 crore (A) respectively. Cost and schedule performance indices related to this project are 0.60 and 0.50 respectively. Cost incurred in this project so far is (a) Rs.320 crore (d) Rs.500 crore
(b) Rs.400 crore (e) Rs.625 crore.
< Answer >
(c) Rs.450 crore
12. Activity AB starts with event A and ends with event B. If EOT and LOT of A are 14 and 20, EOT and LOT of B are 22 and 28, and the duration of the activity AB is 8, which of the following is/are true?
< Answer >
I. The total float of the activity AB is 6. II. The free float of the activity AB is zero. III. The independent float of the activity AB is 2. (a) Only (I) above (d) Both (I) and (II) above
(b) Only (II) above (c) Only (III) above (e) Both (II) and (III) above. < Answer >
13. Following are the cash flows of three projects having a life of 4 years: (Rs. in lakh)
Year 0 1 2 3 4
Project A –1,000 500 400 300 200
Project B –1,500 1,000 –1,500 800 700
Project C –2,000 –1,800 1,200 1,800 1,600
Which of the above projects is/are non-simple
investment(s)? (a) Project A (d) Both Projects A and B
(b) Project B (e) Both Projects B and C.
(c) Project C
14. A project manager faces uncertainty regarding how the economy may perform during the next year. According to the estimates available with him, three different states of economy may occur: strong economic performance, moderate economic performance and weak economic performance. The probabilities associated with the occurrence of these three states of economy and corresponding NPV of the project are as stated below: State of Economy
NPV of the project (Rs. in crore) 75 45 30
Probability
Strong Moderate Weak project’s NPV would be
0.20 0.45 0.35
(a) Rs.23.81 crore (d) Rs.171.11 crore
The semi-variance of the
(b) Rs.46.55 crore (e) Rs.258.19 crore.
(c) Rs.87.08 crore
15. A loan of Rs.20 million along with interest is to be repaid in sixty equal monthly installments. If the loan carries an effective rate of interest of 12% p.a., then the amount of each installment would be approximately (a) Rs.2.00 lakh (d) Rs.5.87 lakh
(b) Rs.3.23 lakh (e) Rs.6.15 lakh.
< Answer >
< Answer >
(c) Rs.4.45 lakh
16. Which of the following statements is/are false with regard to similarity between the Little-Mirlees (L&M) approach and UNIDO approach to Social Cost Benefit Analysis?
< Answer >
I.
Both consider the calculation of shadow prices particularly for foreign exchange savings and unskilled labour. II. Both measure costs and benefits in terms of domestic rupees. III. Both use Discounted Cash Flow analysis. IV. Both measure costs and benefits in terms of uncommitted social income. (a) Only (I) above (c) Both (I) and (II) above (e) Both (III) and (IV) above.
(b) Only (II) above (d) Both (II) and (IV) above < Answer >
17. Different time estimates of the activities related to a project are as follows: Activity 1-2 2-3 1-3 weeks is (a) 11.51%
Time Estimates (in weeks) to tm tp 1.0 2.0 3.0 1.0 1.5 2.5 1.5 4.0 6.5 (b) 34.13%
The chance of this project getting completed in 3
(c) 68.26%
(d) 84.13%
(e) 94.27%.
18. As an impact of capital investment in one of the expansion project, the Debt-Equity ratio of company
< Answer
increases. Which of the following statements would be true, if the asset beta of the company remains unchanged? (a) (b) (c) (d) (e)
>
Equity beta will increase and debt beta will decrease Equity beta will increase and debt beta will not change Equity beta will decrease and debt beta will increase Equity beta will decrease and debt beta will also decrease Equity beta will increase and debt beta will also increase.
19. Jain group of industries started a project having a life of 10 years with an initial outlay of Rs.1,000 crore. Cost of capital and modified NPV related to this project are 12% and Rs.400 crore respectively. The modified IRR of this capital investment would be (a) 12.2%
(b) 13.7%
(c) 14.3%
(d) 15.8%
(e) 16.1%.
20. If the objective is to minimize the value achieved in relation to a given level, then the corresponding term in the objective function while formulating that in a goal programming problem would be (a) Minimize (d–) (c) Minimize (d+ + d–)
(b) Minimize (d+) (d) Minimize (d– – d+)
< Answer >
(b) Contracts phase (d) Production phase
22. State government of Andhra Pradesh is contemplating with an idea of setting up a water purifying plant to provide drinking water to the village of Adoni. It has been observed that the income level of the people of Adoni is Rs.2400. If the base level of income is Rs.3500 and the elasticity of marginal utility of income is 0.6, then during the analysis of income distribution impact as per UNIDO approach of SCBA the weight assigned to this project would be (a) 0.41
(b) 0.68
< Answer >
(e) Minimize (d+ – d–).
21. Which of the following is not a phase of project life cycle according to David Cleland? (a) Conceptual phase (c) Full scale development phase (e) Development phase.
< Answer >
(c) 1.14
(d) 1.25
< Answer >
(e) 1.46.
23. Which of the following statements is false about the Low Price Strategy?
< Answer >
(a)
Pricing low without market information may result in a quotation that is too low compared to the quotation of the competitors (b) A very low price may cause the client to suspect the abilities of the company in estimating works and costs (c) If the company views the projects as a strategic opportunity, then low price strategy is not useful (d) In the emerging field of technology, the client may be more concerned about the ability of the contractor in successfully implementing the project rather than a low price (e) Even if the lowest bidder wins the project, the institution that provides the fund to the client may find the estimates unrealistic and reject funding proposal. 24. Ramanna Constructions Ltd. is evaluating projects P, Q, R, S and T for investment. If project R cannot be accepted unless at least two projects from the projects P, Q, S and T are accepted, then the corresponding constraint can be represented as (a) XR ≤ XP + XQ + XS + XT (c) XR ≤ 2 (XP + XQ + XS + XT) (e) 2XR ≥ XP + XQ + XS + XT.
(b) 2 XR ≤ XP + XQ + XS + XT (d) 4 XR ≤ XP + XQ + XS + XT
25. Which of the following statements is not true with regard to PERT and CPM? (a)
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PERT cannot handle situations in which two or more projects have to be planned together to share the available resources (b) CPM assumes that the cost associated with a project can be divided into two components: direct costs and indirect costs (c) PERT is based on time and variance estimates that consist of six-value weighted averages
< Answer >
(d) CPM and PERT techniques assume that the project has unlimited resources, and they can be assigned for project activities (e) PERT can be used when there is a change in the precedence and sequential relationships of project activities. 26. To confront Chinese products eating up its share of the Indian market, Phillip is planning to invest Rs.34 million in a project of cheap digital diary. Existing market price of similar products lies between the range of Rs.600 and Rs.700. The company did a sensitivity analysis and found the relationship between price per piece and NPV in this range as 0.5P = 1.5N + 83 where P is the price of the product and N is the NPV of the project in Rs. (lakh). If the minimum accepted profitability index of this project is 1.50, the minimum price to be set is (a) Rs.635
(b) Rs.642
(c) Rs.660
(d) Rs.676
(e) Rs.687.
27. A project is being planned with an investment of Rs.200 crore at a debt-equity ratio of 3:2. The principal amount of debt is repayable at the end of 5th year. The funds due to be received on sale of fixed and current assets at the end of 5th year is Rs.230 crore. If short-term borrowings at the end of 5th year is Rs.30 crore then the terminal cash flow as per equity funds point of view, at the end of 5th year, from this project would be (a) 0 (d) Rs.150 crore
(b) Rs.80 crore (e) Rs.230 crore.
< Answer >
< Answer >
(c) Rs.110 crore
28. Goa Auto company has the following capital structure:
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Equity Shares (2,00,000) Rs.40,00,000 10% Preference Shares Rs.10,00,000 14% Debentures Rs.30,00,000 The current market price of the share is Rs.20. The expected dividend next year is Rs.2 per share, which will grow at 7% forever. If the company raises an additional Rs.20,00,000 debt by issuing 15% debentures, the expected dividend increases to Rs.3 and the price of share falls to Rs.15. The growth rate remains the same. The weighted average cost of capital for the firm, assuming a tax rate of 30% is (a) 12.37% (b) 15.40% (c) 16.84% (d) 17.00% (e) 27.00%. 29. Which of the following budgets describes the goals and objectives of an organization within its environment? (a) Financial budget (d) Zero-based budget
(b) Capital budget (c) Operating budget (e) Strategic budget.
30. Which of the following is false with regard to the certainty equivalent method of risk adjustment? (a) (b) (c) (d) (e)
< Answer >
It increases the estimated cash flows for the various years by including a risk premium The adjusted cash flows are discounted at the risk free rate of return It does not assume that risk increases with time at a constant rate The certainty equivalent coefficients are generally higher for the earlier years than the later years The higher is the certainty equivalent coefficient the greater is the likelihood that the cash flow realized will be close to its forecasted value.
END OF SECTION A
< Answer >
Section B : Problems (50 Marks)
1.
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This section consists of questions with serial number 1 – 5.
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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.
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: Activity 1–2 1–3 1–4 2–4 3–4 4–5
Normal duration (days) 9 8 15 5 10 2
Minimum crash duration (days) 6 5 10 3 6 1
Cost of crashing (Rs. per day) 20 25 30 10 15 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 Value Probability Rs.60,000 0.3 Rs.70,000 0.6 Rs.90,000 0.1
Useful life Period Probability 5 years 0.4 6 years 0.4 7 years 0.2
Annual net cash inflows Value Probability Rs.10,000 0.1 Rs.15,000 0.3 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. b.
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. 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 in the same industry are given below:
The equity-betas and debt-equity ratios of three companies engaged
Company Equity-beta Debt-equity ratio Reliable 1.40 2.25 Essel 1.10 1.80 Marvel 1.05 2.00 on market portfolio is 12% p.a..
The risk-free rate is 8% p.a. and the expected return
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
Section C : Applied Theory (20 Marks)
6.
• • • •
This section consists of questions with serial number 6 - 7. Answer all questions.
• • • •
Marks are indicated against each question. Do not spend more than 25 -30 minutes on section C.
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 END OF QUESTION PAPER
Suggested Answers Project Management-I (241) : April 2006 Section A : Basic Concepts 1.
Answer :
(c)
< TO P>
(b)
<
D n Pn 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 :
Reason :Range R h R l 900 200 Rs.700Lac
TO P>
MAD i i Hence option (b) is the correct alternative.
p R R 0.2(360) 0.5(60) 0.30(340) Rs.204 Lac
3.
Answer: (c) Reason: Under Bottom-up approach, estimates are made in terms of machine hours and man-hours and are then converted into rupees by applying appropriate conversion factors. It is not under top- down budgeting. Other options are true with respect to top-down budgeting. Therefore, option (c) is the correct answer.
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4.
Answer :
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(d)
Reason : ‘If cash flows are perfectly correlated, the behavior of cash flows in all periods is alike’. It means that if actual cash flow in one year is α standard deviation to the left of its expected value, cash flows in other years will also be α standard deviation to the left of their respective expected values. In other words, Cash flows of all years are linearly related to one another. But, Moderately correlated cash flows can also be evaluated with the help of a series of conditional probabilty distributions.
Hence option (d) is the correct alternative. 5.
Answer : (a) Reason :Monte Carlo Simulation can handle problems characterized by numerous exogenous variables following any kind of distribution, complex interrelationships among parameters, exogenous variables, and endogenous variables. So, option (a) is incorrect. All the other options are true. Hence option (a) is the correct alternative.
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6.
Answer :
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(c)
Reason : Shadow wage rate is an important element in social cost benefit analysis. It is a function of several factors. They are : (I) The cost associated with urbanisation. (II) The marginal productivity of labour. (III) The cost of having an additional amount committed to consumption when the consumption of worker increases as a result of the higher income he enjoys in urban employment. But marginal cost and marginal cost benefit are not inputs of Shadow Wage Rate. Hence option (c) is the correct option.
7.
Answer :
(d)
Reason : Exponential Smoothing Method is a Time Series Projection Method. Chain Ratio Method, Econometric Method and End use Method are Casual Methods. But Delphi Method is a qualitative method of demand forecasting. Hence option (d) is the correct alternative.
8.
Answer :
(c)
Reason : The derived investment cost for 2,00,000 units of capacity may be calculated as follows: 0.6
200000 100000
20000000
Rs.3.03Cr
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Hence option (c) is the correct alternative.
9.
Answer :
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(b)
Reason :
ERP
=
(Value added at domestic prices – Value added at world
prices) Value added at world prices = = DRC
(350 – 225)/225 0.56
=
(Value added at domestic prices/ Value added at world prices) x Exch ange Rate = (350/225) x 46 = 71.56 When EPR > 0 it means that domestic industry is enjoys protection. A DRC of 71.56 indicates that to generate saving of 1 Dollar from the project a spending of Rs.71.56 is required. Higher DRC is not desirable. Hence option (b) is the correct alternative. 10 Answer : (d) . Reason :Let say minimum acceptable abandonment value of the plant is x. Cash inflow in the first year is Rs.80 crore. Cash inflow in the second year is 1.2 x 80 = Rs.96 crore Present value of the cash flows would be E=
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(96 + x) 80 + (1.12) (1.12) 2
From the company’s point of view E ≥ 500
or or
80 96 + x + ≥ 500 1.12 (1.12)2
80 96 + x ≥ 500 − (1.12) 2 1.12 = (500 × 1.12 – 80) × 1.12 = 537.60
or x ≥ 441.6 So the minimum value of abandonment is Rs.441.6 crore. Hence option (d) is the correct alternative. 11. Answer : (b) Reason :Cost variance = BCWP – ACWP = -160
------------- (1)
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Cost performance index = From (1) we get BCWP = ACWP - 160 ∴ or
BCWP = 0.60 ACWP
− − − − − − (2)
ACWP − 160 = 0.60 ACWP 1−
160 = 0.60 ACWP
ACWP =
160 160 = = 400 (1 − 0.60) 0.40
or Hence option (b) is the correct alternative. < TO P>
12 Answer : (d) . Reason :Total float = LOTB - (EOTA + dAB) = 28 – (14+8) = 6 Free float = EOTB - (EOTA + dAB) = 22 – (14+8) = 0 Independent float = EOTB - (LOTA + dAB) = 22 – (20+8) = – 6 So both (I) and (II) are true. Hence option (d) is the correct alternative. 13 Answer : (b) . Reason :In non-simple investments there would be more than one change in sign of the cash flow. It is true with project B
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Hence option (b) is the correct alternative. 14 Answer : (c) . Reason :Semi-variance
=
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∑ p i (R i − R ) 2
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) . Reason :Principal loan amount = Rs.200 lakhs or Rs.20 million. Repayment : in sixty equated monthly installments. Implicit interest rate = 12% p.a. or 1% per month. ∴ Equated monthly installments are of the size
=
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200 PVIFA (1%, 60)
200 44.955
= ≅ Rs.4.45 lakh. So, alternative (c) is the answer.
16 Answer : (d) . Reason :Though there are some similarities between UNIDO approach and L & M 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.
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So the alternative (d) is the answer. 17 Answer : . Reason :
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(a) Activity
to
tm
tp
te
1–2
1.0
2.0
3.0
2.0
2–3
1.0
1.5
2.5
1.58
1–3
1.5
4.0
6.5
4
Probability (t ≤ 3) =
=
σ 1 3 1 4 5 6
3−4 Pz≤ 5/6
−6 Pz≤ 5
( ) = 11.51%. = Hence option (a) is the correct alternative. P z ≤ − 1.2
18 Answer : (b) . Reason : The beta of debt is insignificant and it is normally considered to be zero. We know that
< TO P>
Equity beta = Asset beta × [1 + D/E (1 – T)]
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) . Reason :Let say terminal value of the cash inflows are x then modified NPV.
< TO 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 ∴ (1 + r) or r
10
=
Ter min al value Initial outlay 4348.19 1000.00
1/ 10
−1
= = 1.158 – 1 = 0.158. ∴ Modified IRR = 15.8%. Hence option (d) is the correct alternative. 20 Answer : (e) . Reason :The various situations and its corresponding term in the objective function while formulating that in a goal programming problem are:
< TO P>
Desired Action
Objective Function Term Attain a minimum level of some Minimize (d–) goal Do not exceed a given level of some Minimize (d+) goal Minimise the deviation from a Minimize (d+ + d–) specified goal level Maximise the value achieved in Minimize (d– – d+) relation to a given goal level Minimise the value achieved in Minimize (d+ - d–) relation to a given level Hence, option (e) is the answer.
21 Answer : (b) . Reason :According to David Cleland, the project life cycle has five phases, they are: (i) the conceptual phase, (ii) the validation phase (iii) the full scale development phase (iv) the production phase (v) the development phase. Hence option (b) is the correct alternative.
< TO P>
22 Answer : (d) . Reason :We know that the weight attached is
< TO P>
wi =
b c1
n
3500 2400
0.6
= = 1.254 Hence option (d) is the correct alternative. 23 Answer: (c) . Reason: If the company is viewing the project as a strategic opportunity, then low 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.
< TO P>
24 Answer : (b) . Reason : If project R cannot be accepted unless at least two projects from the projects. P, Q, S and T
< TO P>
are accepted then the corresponding project interdependency constraint can be represented as 2XR ≤ XP + XQ + XS + XT
25 Answer : (e) . Reason :PERT cannot be used when there is a change in the precedence and sequential relationships of project activities. PERT works in standstill frame work of precedences and sequential relationships.
< TO P>
CPM and PERT techniques assume that the project has unlimited resources, and they can be assigned for project activities. However, in reality, project resources are usually limited. Sometimes activities may be delayed because of the non-availability of resources. That is why the project manager recalculate the activity schedules keeping in mind the availability of resources. 26 Answer : . Reason : Profitability Index =
< TO P>
(d) PV of future cash inflows Initial outlay
As the minimum acceptable profitability index (PI) is 1.50, the minimum PV of future cash inflows should be = PI × IO = 1.5 × 340 = Rs.510 lakh. So, the minimum NPV should be 510 – 340 = 170 lakh 1
0.5P = 1.5 × 170 + 83 = Minimum acceptable price P = 0.5
(1.5 × 170 + 83)
338
= 0.5 = 676.
∴ Minimum price should be set at Rs.676. Hence option (d) is the correct alternative. 27 Answer : .
(b)
< TO P>
Reason :Principal of debt =
200 ×
3 (3 + 2)
= Rs.120 crore
Terminal cash flow according to equity fund’s point of view =
Salvage value of fixed assets + Salvage value of current assets – Repayment of term loans – Repayment of bank borrowings
=
230 – 120 – 30
=
80.
28 Answer : . Reason : will be
(c) The capital structure of Goa Auto after the issue of 15% debentures Source
Amount (in Rs.)
Ordinary shares
40,00,000
10%
Preference shares
10,00,000
14%
Debentures
30,00,000
15%
Debentures
20,00,000
Total:
< TO P>
100,00,000
Cost of equity prior to this
change can be calculated as follows: ke =
D1 2 +g = + 0.07 = 17% Po 20
Cost of equity after the change in capital structure ke =
3 + 0.07 = 27% 15
WACC = w e k e + w p k p + w d k d ( 1 − T )
Substituting the given values, we get WACC = 0.40 × 0.27 + 0.10 × 0.10 + 0.30 × 0.098 + 0.20 × 0.105 = 0.1684 = 16.84% Hence option (c) is the correct alternative. 29 Answer : (e) . Reason :Strategic budgeting is a long range planning based on identifying and specifying organizational goals and objectives. The strengths and weaknesses of the organization are evaluated and risk levels are assessed. Option (a) is not correct because a financial budget combines the cash and capital budgets and proforma financial statements. Option (b) is not correct because capital budgeting involves evaluating
< TO P>
specific long-term investment decisions. Option (c) is not correct because the operating budget is a short management tool. Option (d) is not correct because zero based budgeting is a planning process in which each manager justify a department’s entire budget every year. Hence option (e) is the correct alternative.
30 Answer : . Reason :a.
(a) The certainty equivalent method of risk adjustment does not increases the estimated cash flows for the various years by including a risk premium. b. In applying the certainty equivalent method the adjusted cash flows are discounted at the risk free rate of return. c. It does not assume that risk increases with time at a constant rate . d. The certainty equivalent coefficients are generally higher for the earlier years than the later years because in general higher certainty is associated with earlier years than later years. e. The higher is the certainty equivalent coefficient the greater is the likelihood that the cash flow that will be actually realized will be close to its forecasted value. Hence option (a) is the correct alternative.
< TO P>
Section B : Problems 1.
Production Hours Constraint. Regular production hours available to the firm are limited to 80 hours per week. The management may allow some extra hours of work (overtime) if necessary. Thus the production hours constraint could be set up as follows: x1 x 2 d1 d1 80
Where x1 = x2 = d1 1
d
number of hours used for producing the material A. number of hours used for producing the material B.
=
amount of underutilizaton of available normal production hours.
=
amount of extra hours (overtime) beyond normal production hours allowed by 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,
In this constraint, underutilization 1 is meaningless and hence has been ignored. 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: d
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 < TOP >
2.
a.
Considering the normal duration of the project, the resulting network is given below:
b.
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. 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
crashed
duration (Rs.)
– 3–4 3–4 3–4 1 – 4, 3 – 4
20 19 18 17 16
Crashing cost
Nil 15 = 15 15 + 15 = 30 30 + 15 = 45 45 + 30 + 15 = 90 4–5 15 90 + 40 = 130 1 – 3, 1 – 4, 2 – 4 14 130 + 65 = 195 1 – 3, 1 – 4, 2 – 4 13 195 + 65 = 260 1 – 3, 1 – 4, 1 – 2 12 260 + 75 = 335 the minimum total cost occurs for 15 days of duration, the 15 days.
Overhead cost Rs.60 per day 20 × 60 19 × 60 18 × 60 17 × 60 16 × 60
Total cost (Rs.) 1,200 1,155 1,110 1,065 1,050
15 × 60 1,030 14 × 60 1,035 13 × 60 1,040 12 × 60 1,055 Since optimum length of schedule is < TOP >
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 (Rs.)
Probability
Cumulative probability
Random 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 probability
Random 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 (Rs.)
Probability
Cumulative probability
Random 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: Simulation run
Original cost
Useful life
Annual net cash inflow
Random number
Value (Rs.)
Random number
Period (years)
Random number
Value (Rs.)
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
Period (t)
Cash flow
(1)
Run two
PVIF(6%,n)
(2) × (3)
Cash flow
(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
0.7050
42,124
6 NPV = (Rs.17,876)
Run three Cash flow
(1)
Payback period = 4.05 years
Run four
(3) × (7)
Cash flow
Cash flow
(3) × (11)
(7)
(8)
(9)
(10)
(11)
(12)
0
–70,000
–70,000
– 90,000
– 90,000
–70,000
–70,000
1
20,000
18,868
20,000
18,868
20,000
18,868
2
20,000
17,800
20,000
17,800
20,000
17,800
3
20,000
16,792
20,000
16,792
20,000
16,792
4
20,000
15,842
20,000
15,842
20,000
15,842
5
20,000
14,946
20,000
14,946
20,000
14,946
6
20,000
14,100
NPV = Rs.28,348 Payback years
a. to
Run five
(3) × (9)
98,348
4.
84,248 NPV = Rs.14,248
Payback period will exceed 5 years
Period (t)
(3) × (5)
period
=
4.05
84,248
84,248
NPV = (Rs.5,752)
NPV = Rs.14,248
Payback period will exceed 5 years
Payback period = 4.05 years. < TOP >
Advantage/(Disadvantage) of Making
=
=
Post-tax savings in cost of production due making + Depreciation tax shield {(PVIFA 12%, 10 Years) × Q (P – C) × (1 – t)}
+ = Rs.15,82,056 +
{Dt × (PVIFA 12%, 10 Years) – I} {(5.6502) × 50,000 × (90 – 82) × (1 – 0.30)} + {2,00,000 × 0.30 (5.6502) – 20,00,000)} =
Rs.3,39,012 – Rs.20,00,000 = (Rs. 78,932) As making results in losses it is better to Outsource. P = Purchase price per unit C = Cost of production per unit Q = Quantity demanded in the market t = Tax rate D = Depreciation per annum I = Investment in Fixed assets PVIFA = Present Value Interest Factor of Annuity b.
Minimum demand to avoid losses (Q)
=
I - D t (PVIFA12%, 10 years) (PVIFA12%, 10 years) (P C) (1 t)
=
20,00,000 2,00,000 0.30 5.6502 (5.6502) (90 82) (1 0.30)
=
20, 00, 000 3, 39, 012 31.64
=
52,496 units. < TOP >
5.
a.
Asset beta of Reliable
= =
Asset beta of Essel Asset beta of Marvel ∴ Average asset beta
E 1 D / E (1 t )
1.40 1 2.25(1 0.30)
= 0.5437
=
1.10 1 1.80 0.70
= 0.4867
=
1.05 1 2.00 0.70
= 0.4375
=
0.5437 + 0.4867 + 0.4375 3
∴ Equity beta of MPL =
= 0.4893
D β A 1 + (1 − t ) 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% ∴ Required rate of return on the project or WACC = 11.23% b.
IRR is given by ‘r’ in the following equation:
0
=
–1600 +
10,000 10,000 − (1 + r ) (1 + r ) 2
2 1 ×15(1 − 0.30) + ×12.68 3 3
= 7 + 4.23 =
or, or,
10,000 10,000 − x x2 0 = –1600 + [Replacing (1+r) by x] 1600x2 – 10,000x + 10,000 = 0
x ∴
= =
+ 10,000 ± (10,000) 2 − 4 × 1,600 × 10,000 10,000 ± 6,000 − b ± b 2 − 4ac 2 ( 1600 ) 3,200 2a = = 5 or 1.25
r = 25% or, 400%
So feasible IRR is 25% As the IRR is greater than the required return on the project, so the project is acceptable. However, as the project is a mixed investment, appraising the project in terms of IRR is not appropriate. < TOP >
Section C: Applied Theory 6.
The net present value of a project is equal to the sum of the present value of all the cash flows associated with it. It represents the net benefit over and above the compensation for time and risk. This method of asset selection helps in achieving the objective of financial management, which is maximization of shareholder’s wealth. In other words, NPV decision rule accepts only those projects which enhance the market value or has no change in the market value. The other appraisal techniques are payback period, internal rate of return and benefit cost ratio. Payback period measures the number of years required to recover the initial cash outlay. This method is simple both in application and concept. However, net present value is better than payback period because unlike payback it considers the time value of money and all the cash flows associated with the project. Internal rate of return is the discount rate which makes its net present value equal to zero. IRR is the rate earned on the unrecovered investment balances of the project or the rate of return earned on the initial investment. Like NPV, this method also considers the time value of money and all the cash flows associated with the project. However, it is not uniquely defined as NPV i.e. if there is more than one change in sign of the cash flows there is possibility of multiple IRRs. Moreover IRR gives misleading results if used to choose between mutually exclusive projects with different outlays whereas the results of NPV reflect the true value of the wealth of the shareholders. Benefit cost ratio also known as profitability index measures the present value of returns per rupee invested. Though like NPV it satisfies all the requirement of sound investment criterion it is not suitable for project where the cash outflows occur beyond the current period. < TOP >
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. < TOP > < TOP OF THE DOCUMENT >