Question

Answer in a of 150 words or more. If there is a 10% cost overrun, what happens to the NPV and IRR? If sales are 10% higher than your original estimate, what happens to the NPV and IRR?

Answer 1

If there is 10% cost overrun, this will reduce operational cashflow. Considering other NWC and capital spending requirement same, if cashflows are reduced, hence, NOV will be reduced and IIR will also be reduced.

For 10% extra of sales revenue , cashflow will be increased and hence, NPV and IRR will also be increased.

To prove the above point let look at cashflow at normal scenario:

Base Case
	Year0	Year1	Year2	Year3	Year4	Year5	Year6	Year7
Revenue		$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00
Operational Cost		$ 1,25,000.00	$ 1,25,000.00	$ 1,25,000.00	$ 1,25,000.00	$ 1,25,000.00	$ 1,25,000.00	$ 1,25,000.00
Depriciation		$     10,717.50	$     18,367.50	$     13,117.50	$       9,367.50	$       6,697.50	$       6,690.00	$       6,697.50
EBT		$ 1,64,282.50	$ 1,56,632.50	$ 1,61,882.50	$ 1,65,632.50	$ 1,68,302.50	$ 1,68,310.00	$ 1,68,302.50
Tax @ 35%		$     57,498.88	$     54,821.38	$     56,658.88	$     57,971.38	$     58,905.88	$     58,908.50	$     58,905.88
Operational Cashflow
EBIT/EBT		$ 1,64,282.50	$ 1,56,632.50	$ 1,61,882.50	$ 1,65,632.50	$ 1,68,302.50	$ 1,68,310.00	$ 1,68,302.50
+Depriciation		$     10,717.50	$     18,367.50	$     13,117.50	$       9,367.50	$       6,697.50	$       6,690.00	$       6,697.50
-Tax		$     57,498.88	$     54,821.38	$     56,658.88	$     57,971.38	$     58,905.88	$     58,908.50	$     58,905.88
Total OCF	$                      -	$ 2,32,498.88	$ 2,29,821.38	$ 2,31,658.88	$ 2,32,971.38	$ 2,33,905.88	$ 2,33,908.50	$ 2,33,905.88
Capital Spending
Initial Outlay	$ -7,50,000.00
Salvage								$                    -
Total Project Cashflow	$ -7,50,000.00	$ 2,32,498.88	$ 2,29,821.38	$ 2,31,658.88	$ 2,32,971.38	$ 2,33,905.88	$ 2,33,908.50	$ 2,33,905.88
Cost of Capital	12%
NPV	310785.15
IRR	24%

Now, there is cost overrun of of 10 % and NPV and IRR wil be lower than normal case:

Cost Overrun 10%
	Year0	Year1	Year2	Year3	Year4	Year5	Year6	Year7
Revenue		$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00	$ 3,00,000.00
Operational Cost		$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00
Depriciation		$     10,717.50	$     18,367.50	$     13,117.50	$       9,367.50	$       6,697.50	$       6,690.00	$       6,697.50
EBT		$ 1,51,782.50	$ 1,44,132.50	$ 1,49,382.50	$ 1,53,132.50	$ 1,55,802.50	$ 1,55,810.00	$ 1,55,802.50
Tax @ 35%		$     53,123.88	$     50,446.38	$     52,283.88	$     53,596.38	$     54,530.88	$     54,533.50	$     54,530.88
Operational Cashflow
EBIT/EBT		$ 1,51,782.50	$ 1,44,132.50	$ 1,49,382.50	$ 1,53,132.50	$ 1,55,802.50	$ 1,55,810.00	$ 1,55,802.50
+Depriciation		$     10,717.50	$     18,367.50	$     13,117.50	$       9,367.50	$       6,697.50	$       6,690.00	$       6,697.50
-Tax		$     53,123.88	$     50,446.38	$     52,283.88	$     53,596.38	$     54,530.88	$     54,533.50	$     54,530.88
Total OCF	$                      -	$ 2,15,623.88	$ 2,12,946.38	$ 2,14,783.88	$ 2,16,096.38	$ 2,17,030.88	$ 2,17,033.50	$ 2,17,030.88
Capital Spending
Initial Outlay	$ -7,50,000.00
Salvage								$                    -
Total Project Cashflow	$ -7,50,000.00	$ 2,15,623.88	$ 2,12,946.38	$ 2,14,783.88	$ 2,16,096.38	$ 2,17,030.88	$ 2,17,033.50	$ 2,17,030.88
Cost of Capital	12%
NPV	233771.75
IRR	21%

Now we are analysing the same with 10 % extra revenue and both NPV and IRR will go up:

Revenue increased by 10 %
	Year0	Year1	Year2	Year3	Year4	Year5	Year6	Year7
Revenue		$ 3,30,000.00	$ 3,30,000.00	$ 3,30,000.00	$ 3,30,000.00	$ 3,30,000.00	$ 3,30,000.00	$ 3,30,000.00
Operational Cost		$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00	$ 1,37,500.00
Depriciation		$     10,717.50	$     18,367.50	$     13,117.50	$       9,367.50	$       6,697.50	$       6,690.00	$       6,697.50
EBT		$ 1,81,782.50	$ 1,74,132.50	$ 1,79,382.50	$ 1,83,132.50	$ 1,85,802.50	$ 1,85,810.00	$ 1,85,802.50
Tax @ 35%		$     63,623.88	$     60,946.38	$     62,783.88	$     64,096.38	$     65,030.88	$     65,033.50	$     65,030.88
Operational Cashflow
EBIT/EBT		$ 1,81,782.50	$ 1,74,132.50	$ 1,79,382.50	$ 1,83,132.50	$ 1,85,802.50	$ 1,85,810.00	$ 1,85,802.50
+Depriciation		$     10,717.50	$     18,367.50	$     13,117.50	$       9,367.50	$       6,697.50	$       6,690.00	$       6,697.50
-Tax		$     63,623.88	$     60,946.38	$     62,783.88	$     64,096.38	$     65,030.88	$     65,033.50	$     65,030.88
Total OCF	$                      -	$ 2,56,123.88	$ 2,53,446.38	$ 2,55,283.88	$ 2,56,596.38	$ 2,57,530.88	$ 2,57,533.50	$ 2,57,530.88
Capital Spending
Initial Outlay	$ -7,50,000.00
Salvage								$                    -
Total Project Cashflow	$ -7,50,000.00	$ 2,56,123.88	$ 2,53,446.38	$ 2,55,283.88	$ 2,56,596.38	$ 2,57,530.88	$ 2,57,533.50	$ 2,57,530.88
Cost of Capital	12%
NPV	418603.89
IRR	28%

(Note : These figures are fictitious used for example purpose only - any other data will work)