Interpolation applications in financial analysis, Financial Management

Assignment Help:

In financial analysis, interpolation is used widely in:

  1. Determination of internal rate of return of a project.

  2. Finding out the yield to maturity (ytm) of a bond or debenture.

  3. Other situations where the time value of money is considered and interpolations have to be made while using the present and future value tables.

In financial analysis extrapolation is widely used for:

  1. Forecasting future sales, cost and profit.

  2. Long-term capital requirements.

  3. Production of financial statements for financial institutions, banks, etc.Example 4

The cash inflows of a project involving an initial outlay of Rs.22 lakh is as follows:

Year

Rs. in lakh

1

2

3

4

10

10

6

3                              

The internal rate of return is the rate at which the total value of discounted cash outflows is exactly equal to the total value of discounted cash inflows. The internal rate of return of a project can be determined only through a process of trial and error.

To begin with, let us try the discount rate of 14%.

Using present value interest factor (PVIF) tables, the total of discounted cash inflows will be,

(10 x 0.877) + (10 x 0.769) + (6 x 0.675) + (3 x 0.592) = Rs.22.29 lakh.

Since this figure is higher than the initial outflow of Rs.22 lakh, we must discount at a higher rate.

At r = 15%, the total of discounted cash inflows will be,

(10 x 0.870) + (10 x 0.756) + (6 x 0.658) + (3 x 0.572) = Rs.21.93 lakh.

At the discount rate of 15%, the discounted cash inflows are slightly lower than Rs.22 lakh. It can be concluded that the internal rate of return must lie somewhere between 14% and 15%. The technique of interpolation can be used to determine the exact rate of return.

We now have a series of the following nature:

Rate%

Discounted Cash Flows (DCF)

(Rs. in lakh)


14

22.29

15

21.93

For an intermediary figure of Rs.22 lakh of discounted cash flow we need to interpolate the rate.

The linear approximation method may be used to interpolate. We know that when the rate increases by 1%, the DCF falls from 22.29 to 21.93 or the descent in DCF for 1% ascent in rate is (22.29 - 21.93). We also know that the interest rate must be higher than 14%, but less than 15%.

At the exact rate, the descent must be (22.29 - 22.00). When descent is

(22.29 - 21.93), the increase in rate is 1. For a descent of (22.29 - 22)

the increase in rate must be   882_applications in financial analysis.png
The internal rate of return = 14% + 1189_applications in financial analysis1.png
  = 14 + 0.806 ~ 14.81%

Related Discussions:- Interpolation applications in financial analysis

Statement of total comprehensive income, At 31 July 2010 this instrument me...

At 31 July 2010 this instrument meets the definition of a derivative: Small or no initial investment. Its value is dependent on an underlying economic item; exchange ra

Regular payback period, The director of capital budgeting for a firm has re...

The director of capital budgeting for a firm has recognized two mutually exclusive projects, A and B, with the following expected net cash flows:

Methods of easing cash shortages, Q. Methods of easing cash shortages? ...

Q. Methods of easing cash shortages? There are several techniques which can potentially offset the effects of cash shortages. In the long-term nevertheless the adequacy of cash

Compare the ifrs and gaap revenue recognition policies, SUPERVALU INC . ...

SUPERVALU INC . , a large US retail grocer, had $36.1 billion in sales for its fiscal year ended February 25, 2011. SUPERVALU currently reports using US GAAP. The controller of

Explain savings and loan associations, Savings and loan associations Hi...

Savings and loan associations Historically savings along with loan associations (S&Ls) and thrift institutions have concentrated mostly on residential mortgages by acquiring fu

Case studies, •?Detailed information should form the part of your answer (W...

•?Detailed information should form the part of your answer (Word limit 150 to 200 words). Case let 1 This case provides the opportunity to match financing alternatives with the nee

Define supply curve for a good is totally inelastic, Suppose the supply cur...

Suppose the supply curve for a good is totally inelastic.  If the government imposed a price ceiling below the market-clearing level, would a deadweight loss result?  Explain.

List the main features of ordinary shares, Question 1 Describe the types o...

Question 1 Describe the types of investment decisions Question 2 List the main features of ordinary shares Question 3 List the assumptions of Walter's dividend model. Ex

Risk, You are still a consultant for the Excellent Consulting Group. You ha...

You are still a consultant for the Excellent Consulting Group. You have completed the first assignment, developing and testing a forecasting method based on linear regression (Case

Wacc based on the president''s preference, Sapp Trucking's balance sheet il...

Sapp Trucking's balance sheet illustrates a total of noncallable $45 million long-term debt with a coupon rate of 7.00% and a yield to maturity of 6.00%.  This debt presently has a

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd