Project Ka Bazigaar 1

Cost-Benefit Analysis By-Rahul Jain

Cost-Benefit Analysis :Project Appraisal Market Appraisal (Demand forecasting, Market size etc) Technical Appraisal ( Location, processes, design, technology) Financial Appraisal Socio Economic Appraisal ( Societal issues) & Ecological Appraisal

Cost Benefit Analysis ? Analysis of potential projects. Long-term decisions; involve large expenditures. Very important to firm’s future.

Financial Projection: Various components Estimation of cost of Project and its timings Estimation of likely revenues during each period Cost of capital Planning horizon of project Risk of the project ( Scenario Analysis)

Financial Criteria ROI Gross Margin /Sales Ratio, Net Margin/Sales Ratio BreakEven Payback period, IRR, NPV Other Ratios and Measures

ROI – Return on Investment Profit /Investment Desirable : It should be more than 18%

ROI ( Under all scenarios)- For Business/ Marketing Plan Steps: 1) Forecast Sales & Investments 2) Forecast Costs & Budgets 3) Forecast Income statement 4) Calculate ROI

ROI- For Marketing Campaigns Steps: 1) Forecast Sales & Investments In Investments consider following: Investment in Marketing campaign+ Cost of Sales 1) Forecast Direct Costs 2) Forecast Gross Margin ( Sales-Cost of sales- Recurring Marketing Investment) 3) Calculate ROI

Gross Margin /Sales Ratio Suitable for Measuring the effectiveness of Marketing compaigns Suitable for indicating the direct efficiency of business

Net Margin /Sales Ratio Suitable for Measuring the effectiveness of Marketing compaigns Suitable for indicating the overall efficiency of business

Breakeven Sales Breakeven = Fixed Costs/ Contribution Margin Ratio. This explain the Sales to be achieved for recovering the costs.

What is the payback period? The number of years required to recover a project’s cost, or how long does it take to get the business’s money back?

Payback for Franchise L (Long: Most CFs in out years) = CF t Cumulative Payback L 2+30/80 = years

Franchise S (Short: CFs come quickly) CF t Cumulative Payback S /50 = 1.6 years =

Strengths of Payback: 1.Provides an indication of a project’s risk and liquidity. 2.Easy to calculate and understand. Weaknesses of Payback: 1.Ignores the TVM. 2.Ignores CFs occurring after the payback period.

NPV:Sum of the PVs of inflows and outflows. Cost often is CF 0 and is negative.

What’s Franchise L’s NPV? % Project L: = NPV L NPV S = $19.98.

Rationale for the NPV Method NPV= PV inflows - Cost = Net gain in wealth. Accept project if NPV > 0. Choose between mutually exclusive projects on basis of higher NPV. Adds most value.

Using NPV method, which franchise(s) should be accepted? If Franchise S and L are mutually exclusive, accept S because NPV s > NPV L. If S & L are independent, accept both; NPV > 0.

Internal Rate of Return: IRR 0123 CF 0 CF 1 CF 2 CF 3 CostInflows IRR is the discount rate that forces PV inflows = cost. This is the same as forcing NPV = 0.

NPV: Enter r, solve for NPV. IRR: Enter NPV = 0, solve for IRR.

What’s Franchise L’s IRR? IRR = ? PV 3 PV 2 PV 1 0 = NPV Enter CFs in CFLO, then press IRR: IRR L = 18.13%.IRR S = 23.56%.

Rationale for the IRR Method If IRR > WACC, then the project’s rate of return is greater than its cost-- some return is left over to boost stockholders’ returns. Example:WACC = 10%, IRR = 15%. Profitable.