Financing of Projects –Financial
Appraisal of Project- –BCG matrix
Lesson 17
SMIJA P K
Before Idea commercialisation or when managers are closer to
commercialisation they face questions such as
How much would it cost to bring the idea into market?
What price would we ask?
How much units could we expect to sell at that price?
What would be our costs of marketing , production and service?
Two tools employed for this purpose are
1. Breakeven analysis
2. Discounted cash flow
The process of assessing economic merits of innovations or new
products or investments – Financial appraisal
https://hbr.org/2014/07/a-quick-guide-to-breakeven-
analysis
Break even analysis: Managers typically use breakeven analysis to set a price
to understand the economic impact of various price- and sales-volume scenario.
The analysis tells you how much (or how much more) you need to sell in order to
pay for a fixed investment. – in other works at what point you will break even on the
cash flow produced by a new product or service.
BEA helps you to determine the volume level at which the total after tax revenue
contribution from a product or an investment covers its total fixed cost
Fixed costs :eg insurance, salaries, rent or lease payments
Variable costs : labour, raw materials , the more units are made the more of these
items are consumed.
Contribution margin : The amount of money that every sold unit contributes to
paying for fixed costs. It is defined as the net unit revenue minus variable costs per
unit .
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Eg: You have an idea fof a new and improved version of your
company’s vegetable processing machine. After some
investigations , you estimate that company will incur Rs
5,00,000 in fixed costs in developing the tool. Marketing
department says each machine should sell for Rs 75.
manufacturing department estimates cost per unit will be Rs
22. Find the break even volume .
1. Find the unit contribution margin
Price per unit – variable cost per unit = Rs53
2. Divide the amount of investment or fixed costs with unit
contribution margin to get the break even volume.
BIV = Total fixed costs/unit contribution margin
= 5,00,000/ 53
= 9,434 units
Company has to sell 9,434 vegetable processors to recover
the total investment as fixed capital.
Discounted cash flow (DCF) Analysis
• To evaluate economic merits of innovations or new
products
• it is a financial tool based on time value of money.
Time value of money is a mathematically based recognition that money
received today is worth more than an equal amount of money received
months or years in the future .
Time value of Money
Time Value of an Investment with 10 percent
Compounded Interest
Perio Beginning
Interest Earned Ending
d Value(Rs)
Value(Rs)
1 300,000 +30,000 330,000
2 330,000 +33,000 363,000
3 363,000 +36,300 399,300
4 399,300 +39,930 439,230
5 439,230 +43,923 483,153
Here Present value = 3,00,000
Number of years = 5
Compound interest = 10%
3,00,000x 0.1= 30,000
Table gives the future value of Rs 1, given various
compounding values and compounding periods .Each value
is referred to as FVIF –Future Value Interest Factor .
Future Value of $1 (FVIF)
Periods 8% 9% 10% 11% 12%
1 1.0800 1.0900 1.1000 1.1100 1.1200 Future value = Present value x
2 1.1664 1.1881 1.2100 1.2321 1.2544 FVIF
3 1.2597 1.2950 1.3310 1.3676 1.4049
4 1.3605 1.4116 1.4641 1.5181 1.5735
5 1.4693 1.5386 1.6105 1.6851 1.7623
6 1.5869 1.6771 1.7716 1.8704 1.9738 Rs 3,00,000x 1.6105=
7 1.7138 1.8280 1.9487 2.0762 2.2107 4,83,150
8 1.8509 1.9926 2.1436 2.3045 2.4760
9 1.9990 2.1719 2.3579 2.5580 2.7731
10 2.1589 2.3674 2.5937 2.8394 3.1058
11 2.3316 2.5804 2.8531 3.1518 3.4786
12 2.5182 2.8127 3.1384 3.4985 3.8960
Net present Value
Present value is the monetary value today of a future payment
discounted at some compound interest rate . This is calculated
through discounting or reverse compounding. For this we use PVIF
– Present Value Interest Factor
Net Present Value is the present value of one or
more future cash flows less any initial investment
cost .
Tables are available for calculating the present value
of Rs 1 received in the future within a range of
discount factors and discounting periods.
Present Value of $1 (FVIF)
Period 2% 4% 6% 8% 10% 12%
1 0.980 0.962 0.943 0.926 0.909 0.893
Future value x PVIF= present value
2 0.961 0.925 0.890 0.857 0.826 0.797
3 0.942 0.889 0.840 0.794 0.751 0.712 4,83,153 x 0.621 = 3,00,038 ( there is
4 0.924 0.855 0.792 0.735 0.683 0.636 minute difference because PVIF values
5 0.906 0.822 0.747 0.681 0.621 0.567 in table are rounded
6 0.888 0.790 0.705 0.630 0.564 0.507
7 0.871 0.760 0.665 0.583 0.513 0.452
8 0.853 0.731 0.627 0.540 0.467 0.404
9 0.837 0.703 0.592 0.500 0.424 0.361
10 0.820 0.676 0.558 0.463 0.386 0.322
Net Present Value is the present value of one or
more future cash flows less any initial investment
cost .
Net Present Value of Amalgamated cash Flow
Cash Flows(in PVIF PV(in
$1000) $10,000)
Year 0 -250 -250.00
Year 1 +70 0.909 +63.63
Year 2 +70 0.826 +57.82
Year 3 +70 0.751 +52.57
Year 4 +70 0.683 +47.81
Year 5 +70 0.621 +43.47
Total +15.30
If the resulting NPV is a positive number, and no other
investments are under consideration, then the current
investment should be pursued. Its compound annual
return is at least 10%.
Internal Rate of Return
(IRR)
It helps to rank the desirability of various opportunities. It is defined as the discount rate at
which NPV of an investment equals zero
Cash Flows(in PVIF PV(in rs
rs 1000) 10,000)
Year 0 -250 -250.00
Year 1 +70 0.909 +63.63
Year 2 +70 0.826 +57.82
Year 3 +70 0.751 +52.57
Year 4 +70 0.683 +47.81
Year 5 +70 0.621 +43.47
Total +15.30
Here the NPV value rs 15,300 suggests that these numbers if realised would cover the
cost of capital(at 10%) and contribute an additional present value of rs 15,300
IRR captures the discount rate and the additional present value contribution in a single
number. To calculate it, we need to determine the discount rate that would reduce NPV
to exactly zero. Here IRR must be greater than 10% because the cash flow discounted
at 10% produced a positive NPV.
We can calculate IRR through an iterative process that uses higher and higher
discount rates. Eventually we would get the one that would produce an NPV of zero.
Sensitivity Analysis
Every business forecast includes one or more assumptions. What would happen if one or more
of these failed to hold? Sensitivity analysis helps you to ask that question and to see the
ramifications of incremental changes in the assumptions that underly a particular projection.
Eg: Sensitivity analysis for break-even analysis
Assumption 1: Fixed cost and variable cost - instead of one single point estimate, use a range
of likely cost scenarios.
Assumption 2: Unit contribution – establish a range of likely selling prices for the new product
or service.
Similarly we can repeat the exercise for NPV calculations as well.
BCG matrix
What Is a BCG Growth-Share Matrix?
The Boston Consulting Group (BCG) growth-share matrix is a planning tool that uses graphical representations of a
company’s products and services in an effort to help the company decide what it should keep, sell, or invest more in.
The matrix plots a company’s offerings in a four-square matrix, with the y-axis representing the rate of market growth
and the x-axis representing market share. It was introduced by the Boston Consulting Group in 1970.1
KEY TAKEAWAYS
•The BCG growth-share matrix is a tool used internally by management to assess the current state of value of a firm's
units or product lines.
•BCG stands for the Boston Consulting Group, a well-respected management consulting firm.
•The growth-share matrix aids the company in deciding which products or units to either keep, sell, or invest more in.
•The BCG growth-share matrix contains four distinct categories: dogs, cash cows, stars, and question marks.
•The matrix helps companies decide how to prioritize their various business activities.
