---
title: "Conventional vs project financing; ARR, NPV, PI, payback"
subject: "Project Engineering"
chapter: 6
key: "semester_7/project_engineering:conventional-vs-project-financing-numerical"
source: https://www.bctengineer.com/q/semester_7/project_engineering/conventional-vs-project-financing-numerical
site: BCT Engineering
---

# Conventional vs project financing; ARR, NPV, PI, payback

Project Engineering · Chapter 6: Introduction to Project Financing

- Asked in: 2080 Bhadra, 6 marks
- Video: [How to calculate the Net Present value (NPV)](https://www.youtube.com/watch?v=TU4RNBK9j3k) — Corporate finance with Medson Nyirenda
- Answer checked by Claude Opus 5.5 (high effort) on 2026-10-14
- Page: https://www.bctengineer.com/q/semester_7/project_engineering/conventional-vs-project-financing-numerical
- Whole chapter: https://www.bctengineer.com/md/semester_7/project_engineering/chapter-6

## Question

Differentiate between conventional and project financing. A project has an initial investment of Rs 25,00,000 and a salvage value of Rs 5,00,000. The annual revenue of the project is Rs 10,00,000 and the annual expenses is Rs 2,00,000. Calculate ARR, NPV, Profitability Index (PI) and simple payback period of the project.

## Short answer

Conventional finance relies on the firm's credit with full recourse, whereas project finance relies solely on project cash flows and assets with non-recourse. With 5-year life and 10% discount, net annual cash flow Rs 8,00,000 yields ARR 26.67%, NPV Rs 8,43,090, PI 1.337, payback 3.125 years.

## Answer

#### Conventional finance vs project finance

| Basis | Conventional (corporate) finance | Project finance |
|---|---|---|
| Basis of lending | Balance sheet and credit of the whole firm | Cash flow and assets of the project only |
| Borrower | Existing company | Separate project company (SPV) |
| Recourse | Full recourse to the company/owners | Non-recourse or limited recourse |
| Debt-equity ratio | Low to moderate | High (70 to 80% debt) |
| Risk | Carried by the firm | Shared by many parties through contracts |
| Appraisal | Overall financial position | Detailed feasibility and financial model |
| Repayment period | Short to medium | Long, as per the project life |
| Cost and documents | Simple and cheaper | Complex and costly |

#### Numerical

The project life and discount rate are not given. Assumptions: **life = 5 years, discount rate = 10%**, straight-line depreciation, and tax is ignored.

- Net annual cash flow = 10,00,000 - 2,00,000 = Rs 8,00,000
- Depreciation = (25,00,000 - 5,00,000)/5 = Rs 4,00,000 per year
- Average annual profit = 8,00,000 - 4,00,000 = Rs 4,00,000

**ARR**

$$
\begin{aligned}
\text{Average investment} &= \frac{25{,}00{,}000 + 5{,}00{,}000}{2} = 15{,}00{,}000\\
ARR &= \frac{4{,}00{,}000}{15{,}00{,}000} \times 100 = 26.67\%
\end{aligned}
$$

**NPV** (annuity factor at 10%, 5 years = 3.7908; PV factor at year 5 = 0.6209)

$$
\begin{aligned}
PV_{inflow} &= 8{,}00{,}000 \times 3.7908 + 5{,}00{,}000 \times 0.6209 = 33{,}43{,}090\\
NPV &= 33{,}43{,}090 - 25{,}00{,}000 = 8{,}43{,}090
\end{aligned}
$$

**Profitability index**

$$
PI = \frac{33{,}43{,}090}{25{,}00{,}000} = 1.337
$$

**Simple payback period**

$$
\text{Payback} = \frac{25{,}00{,}000}{8{,}00{,}000} = 3.125\ \text{years} = 3\ \text{years}\ 1.5\ \text{months}
$$

**Answer: ARR = 26.67%; NPV = Rs 8,43,090; PI = 1.337; payback = 3.125 years.** NPV is positive and PI is more than 1, so the project is acceptable.

## Check yourself

The answer's key points as multiple-choice questions, with the correct option and why.

1. How does recourse differ between conventional and project finance?
   A. Conventional is non-recourse; project finance is full recourse
   B. Conventional is full recourse; project finance is non-recourse or limited recourse
   C. Both are non-recourse
   D. Both are full recourse
   Answer: B. Corporate finance has full recourse to the company; project finance is non-recourse or limited. (Key point: Recourse difference)

2. What is ARR in the problem?
   A. 50%
   B. 16%
   C. 26.67%
   D. 32%
   Answer: C. Average annual profit 400,000 divided by average investment 1,500,000 = 26.67%. (Key point: ARR)

3. What are NPV and PI?
   A. NPV = Rs 3,343,090; PI = 0.74
   B. NPV = Rs 800,000; PI = 1.0
   C. NPV = Rs 500,000; PI = 1.337
   D. NPV = Rs 843,090; PI = 1.337
   Answer: D. PV inflow = 3,343,090; NPV = 3,343,090 - 2,500,000; PI = 3,343,090/2,500,000. (Key point: NPV and PI)

4. What is the simple payback period?
   A. 3.125 years
   B. 5 years
   C. 2.5 years
   D. 3.125 months
   Answer: A. Payback = 25,00,000 / 8,00,000 = 3.125 years. (Key point: Payback)

## Related in Project Engineering

- [Sources of finance; ARR, payback, IRR, PI decision](https://www.bctengineer.com/question.md?key=semester_7%2Fproject_engineering%3Aproject-finance-sources-investment-decision-c75) — Project Engineering, chapter 6
- [EPS and book value; ABC project Rs 6,00,000](https://www.bctengineer.com/question.md?key=semester_7%2Fproject_engineering%3Aeps-bv-abc-project-600000-b79) — Project Engineering, chapter 6
- [EPS and book value; Rs 10,00,000, 3500 shares](https://www.bctengineer.com/question.md?key=semester_7%2Fproject_engineering%3Aeps-bv-capital-1000000-3500-shares) — Project Engineering, chapter 6
- [EPS and book value; capital Rs 5,00,000](https://www.bctengineer.com/question.md?key=semester_7%2Fproject_engineering%3Aeps-bv-capital-500000-2000-shares) — Project Engineering, chapter 6
- [EVA; 60 days, 25% work, Rs 12,00,000](https://www.bctengineer.com/question.md?key=semester_7%2Fproject_engineering%3Aeva-numerical-60-days-25-percent) — Project Engineering, chapter 4
- [Capital budgeting; ARR numerical, Rs 100000](https://www.bctengineer.com/question.md?key=semester_7%2Fproject_engineering%3Acapital-budgeting-arr-numerical-c72) — Project Engineering, chapter 6

## Related in other subjects

- [Sensitivity on investment, revenue and life; interpret](https://www.bctengineer.com/question.md?key=semester_6%2Fengineering_economics%3Asensitivity-30-initial-100000-useful-10) — Engineering Economics, chapter 6
- [NPV and payback of a startup project](https://www.bctengineer.com/question.md?key=semester_7%2Fentrepreneurship_development%3Anpv-payback-startup-project) — Entrepreneurship Development, chapter 5
- [Sensitivity to investment, revenue and life](https://www.bctengineer.com/question.md?key=semester_6%2Fengineering_economics%3Asensitivity-30-investment-revenue-life-500000) — Engineering Economics, chapter 6
- [AW sensitivity to investment and net annual cash flow](https://www.bctengineer.com/question.md?key=semester_6%2Fengineering_economics%3Asensitivity-aw-500000-75000) — Engineering Economics, chapter 6