Please help me solve question #6 and questions a, b, and c Mini-Case It\'s been
ID: 2732002 • Letter: P
Question
Please help me solve question #6 and questions a, b, and c
Mini-Case It's been four months since you took a position as an assistant fi 6. Now that they are comfortable with your skills, your boss nancial analyst at Caledonia Products. During that time, you've would like you to look at a new project. This new project had a promotion and you are now working as a special assistant involves the purchase of a new plasma cutting tool that for cap tal budgeting, reporting directly to the CEO. Your latest can be used in its metal works division. The products assignment involves the analysis of several risky projects. Be- manufactured using the new technology are expected to cause this is your first assignment dealing with risk analysis, you sell for an average price of $300 per unit, and the have been asked not only to provide a recommendation on the company analyst performing the analysis expects the projects in question, but also to respond to a number of ques- firm can sell 20,000 units per year at this price for a tions aimed at judging your understanding of risk analysis and period of five years. To get into this business will require capital budgeting. The memorandum you received outlining the purchase of a $2 million piece of equipment that has a residual or salvage value in five years of $200,000. n your assignment follows: addition, the firm expects to have to invest an addtional TO The Special Assistant for Capital Budgeting $300,000 in working capital to support the new FROM: Mr. Momison, CEO, Caledonia Products business. Other pertinent information conceming the business venture is provided below: RE: Capital Budgeting and Risk Analysis $2,000,000 Initial cost of equipment Provide a written response to the following questions: 1. Explain how sensitivity analysis and scenario analysis are $200,000 useful tools for evaluating project risk. $300,000 2. What are real options? How does the presence of optionality in the investments that firms make cause the traditionally calculated NPV of a $360,000 project to be underestimated? of using Explain how simulation works. What is the value Discount rate or required rate of retum In addition, estimates for unit sales, selling price How can breakeven analysis be helpful in evaluating variable cost per unit, and fixed cash operating expenses for the base-case, worst-case and best-case are 5. What is sensitivity analysis and what is its purpose? described below: Best-Case Worst-case Base-Case 25,000 15,000 20,000 it sales (450,000) 360.000 $360,000 b. Evaluate the NPV of the investment under the worst a. Estimate the cash flows for the investment under the assumptions case assumptions provided above. base-case or expected value listed above. Calculate the project NPV for these cash c. Evaluate the NPV of the investment under the bestExplanation / Answer
a. Calculation of cash inflow:
Base case :
Npv=-2000000-300000+1158000{[1-(1+.12)^-5]/.12}+(200000+300000)(1+.12)^-5
Npv=-2000000-300000+1158000{3.6048}+(200000+300000)(.5674)
=$2158044.27
b.
Worst case :
Npv=-2000000-300000+213000{[1-(1+.12)^-5]/.12}+(200000+300000)(1+.12)^-5
Npv=-2000000-300000+213000{3.6048}+(200000+300000)(.5674)
=-$1248477.6
c.
Best case :
Npv=-2000000-300000+2488000{[1-(1+.12)^-5]/.12}+(200000+300000)(1+.12)^-5
Npv=-2000000-300000+2488000{3.6048}+(200000+300000)(.5674)
=$6952442.4
Base case worst case best case Sales 6000000 3750000 8250000 Less variable cost 4000000 3150000 4500000 Less Fixed cost 500000 450000 350000 Less Depreciation expense 360000 360000 360000 Income 1140000 -210000 3040000 Less taxes(30%) 342000 63000(tax credits) 912000 Net operating income 798000 -147000 2128000 Add depriciate 360000 360000 360000 Net cash inflow 1158000 213000 2488000