CAIIB Paper 3 Module B Quiz 6

NPV = present value of inflows − initial outlay = ₹6.2 lakh − ₹5 lakh = ₹1.2 lakh. Positive NPV indicates expected value addition at the discount rate used.

For a conventional independent project, IRR above the required return generally indicates positive NPV. NPV remains the preferred criterion for mutually exclusive projects with unusual cash flows.

Equivalent annual value converts NPV or cost into an annual equivalent and can help compare repeatable alternatives with unequal lives. The method relies on appropriate repeatability and other assumptions.

Nominal cash flows should be discounted at a nominal rate, while real cash flows should be discounted at a real rate. Mixing nominal and real measures produces inconsistent valuations.

Terminal disposal proceeds may create a taxable gain or deductible loss relative to tax written-down value, depending on the applicable tax rules. Selling costs and tax effects should be reflected in after-tax cash flow.

Faster tax depreciation may bring tax savings forward, increasing their present value. The result depends on tax law, taxable income and whether deductions can be used.

Economic life reflects the period over which operating benefits justify ownership relative to replacement or other alternatives. It may differ from the accounting depreciation life.

Post-audits compare actual performance with projections, identify forecast errors and implementation issues, and improve accountability and future capital-budgeting decisions.

Foreign-currency cash flows should be discounted using a rate consistent with that currency’s inflation and risk assumptions, or converted consistently into home currency. Exchange and country risks also require consideration.

The parent’s value depends on cash flows it can actually receive. Remittance controls, taxes, blocked funds and timing can affect the amount and present value of cash available to the parent.

Currency movements can alter the home-currency value of operating cash flows, assets, liabilities and remittances. The net effect depends on the currency of revenues, costs, debt and restrictions.

Portfolio investment generally involves financial assets such as shares and bonds without the same intent to exercise lasting management control characteristic of FDI. Regulatory definitions and thresholds can vary.

CAPM required return = Rf + β × market risk premium = 5% + 0.8 × 7% = 10.6%.

A country-risk premium can be used to reflect additional country-specific risk when appropriate. The analyst must ensure the risk is not already reflected in cash flows or another risk adjustment.

A forward contract can lock an exchange rate for a future conversion, reducing uncertainty in the INR value of a known foreign-currency receipt. It also removes the opportunity to benefit from favourable rate movements.

The group should focus on actual consolidated cash flows and comply with transfer-pricing rules. Internal prices can affect tax allocation and local incentives, but should not be treated as creating value by themselves.

Expected NPV = 0.25×8 + 0.50×3 + 0.25×(−2) = 2 + 1.5 − 0.5 = ₹3 lakh.

Equal expected values do not imply equal risk. Decision-makers should assess downside outcomes, volatility, liquidity impact and risk appetite, especially where severe losses could threaten the firm.

A real option is managerial flexibility embedded in a real investment, such as the ability to delay, expand, contract or abandon a project as uncertainty resolves. Conventional NPV may understate this flexibility.

An abandonment option allows management to stop the project and recover salvage value when continuation is unattractive. This can reduce downside risk and add value, subject to the cost and feasibility of exit.