Varun Ltd. is evaluating a project whose life will not fall below 2 years, involving production and sale of 2,60,000 units of canned pineapple tins at the selling price of ₹100 per unit. The following cash flows have bee

(i) Calculation of NPV Year Cash Flow PVF @10% PV 0 (28,000) 1.000 (28,000) 1 18,000 0.9091 16,364 2 18,000 0.8264 14,875 Total = 1.7355 NPV = 3239 Since NPV is positive, project can be accepted (ii) Test for Sensitivity a. Initial Outlay As the NPV is ₹3,239. If initial outlay is to increased by the amount equivalent to NPV i.e ₹3,239 then NPV will become Zero Sensitivity (%) = (Change/Base) x 100 = (3,239/28,000) x 100 = 11.57% b. Sales Volume Let unit sold to get NPV = 0 is x (100x - 8000) 1.7355 - 28,000 = 0 173.55x - 13,884 - 28000 = 0 x = 241.33 Sensitivity (%) = [(260 - 241.33) / 260] x 100 = 7.18% c. Selling Price Let Selling Price = x (260x - 8000) 1.7355 - 28,000 = 0 x = 92.82 Sensitivity (%) = [(100 - 92.82) / 100] x 100 = 7.18% d. Variable Costs PV of variable Cost (₹8,000 × 1.7355) = ₹13,884 It can be increased by ₹3,329 (NPV will then be zero) Sensitivity (3,239 / ₹13,884) x 100 = 23.33% e. Discount Rate The NPV will be zero at IRR. Hence, we need to compute IRR NPV @ 18% & 20% Year Cash Flow PVF @18% PV@18% PVF @20% PV@20% 0 (28,000) 1.000 (28,000) 1.0000 (28,000) 1 18,000 0.8474 15,253 0.8333 14,999 2 18,000 0.7182 12,928 0.6944 12,499 NPV = 181 NPV = 502 IRR = [18 + {181 / (181 + 502)} × 2] = 18.53% Change = 18.53 - 10 = 8.53% Sensitivity = (8.53 / 10) × 100 = 85.3% Evaluation Initial Outlay: 11.57% Sales Volume: 7.18% Selling Price: 7.18% Variable Costs: 23.33% Discount Rate: 85.30% Alternative Solution to 5(a)(ii) Considering the effect of cost of capital 10%, Sensitivity Analysis of following variables is as under: a. Initial Outlay Initial cost increases by 10% NPV = 18,000 × 1.7355 - 30,800 = 439 % change in NPV = (3239 - 439) / 3239 = 86.45 b. Sales Volume Sales Volume decrease by 10% NPV = (23,400 - 8,000) × 1.7355 - 28,000 = (1273) % change in NPV = [3239 - (-1273)] / 3239 × 100 = 139.3% c. Selling Price Selling Price decreases by 10% NPV = (23,400 - 8,000) × 1.7355 - 28,000 = (1273) % change in NPV = [3239 - (-1273)] / 3239 × 100 = 139.3% d. Variable cost Variable Cost increases by 10% NPV = 17,200 × 1.7355 - 28,000 = 1,850 % change in NPV = (3239 - 1850) / 3239 × 100 = 42.88% e. Discount Rate Discount rate increase by 10% NPV = 18,000 × 1.7125 - 28,000 = 2,825 % change in NPV = (3239 - 2825) / 3239 × 100 = 12.78% (iii) Name the variable to which the project is most sensitive and least sensitive. Thus, by changing the factor by 10%, the NPV decreases by Initial Outlay: 86.45% Sales Volume: 139.3% Selling Price: 139.3% Variable Costs: 42.88% Discount Rate: 12.78% The project is most sensitive to sales volume and sales price, and least sensitive to discount rate.