Exam 10: Project Analysis

The following options associated with a project increases managerial flexibility: I. Option to expand II. Option to abandon III. Production options IV. Timing options

Briefly discuss break-even analysis.

A project has an initial investment of 100. You have come up with the following estimates of the projects with cash flows. If the cash flows are perpetuities and the cost of capital is 10%. What does a sensitivity analysis of NPV (no taxes) show?

KMW Inc. sells a finance textbook for $150 each. The variable cost per book is $30 and the fixed cost per year is $30,000. The process of creating a textbook costs $150,000 and the average book has a life span of 3 years. Using straight line depreciation and a tax rate of 25%, what is the economic or present value break even number of books that must be sold given a discount rate of 12%?

You are planning to produce a new action figure called "Hillary". However, you are very uncertain about the demand for the product. If it is a hit, you will have net cash flows of $50 million per year for 3 years (starting next year). If it fails, you will only have net cash flows of $10 million per year for 2 years (starting next year). There is an equal chance that it will be a hit or failure (probability = 50%). You will not know whether it is a hit or a failure until the first year's cash flows are in. You have to spend $80 million immediately for equipment and the rights to produce the figure. If you can sell your equipment for $60 million once the first year's cash flows are received, calculate the NPV with the abandonment option. (The discount rate is 10%)

Monte Carlo simulation is likely to be most useful:

Monte Carlo simulation should be used to get the distribution of NPV values for a project.

Option to expand a project is a:

The NPV break-even point occurs when:

Petroleum Inc. owns a lease to extract crude oil from sea. It is considering the construction of a deep-sea oil rig at a cost of $50 million (I0) and is expected to remain constant. The price of oil is $50/bbl and the extraction costs are $20/bbl. The quantity of oil Q = 200,000 bbl per year forever. The risk-free rate is 10% per year which is also the cost of capital (Ignore taxes). Suppose the oil price is uncertain and can be $70/bbl or $40/bbl next year. If the project if postponed by one year, calculate the value of the option to wait for one year: (approximately)

Explain the usefulness of decision trees in project analysis.

Tangible assets usually have higher abandonment value than intangible ones.

In constructing a simulation model of an investment project, one can ignore possible interdependencies between variables.

Project analysis, in addition to NPV analysis, includes the following procedures: I. Sensitivity analysis II. Break-even analysis III. Monte Carlo simulation IV. Scenario Analysis

Monte Carlo simulation involves the following steps: I. Step 1: Modeling the project II. Step 2: Specifying probabilities III. Step 3: Simulate the cash flows IV. Step 4: Calculate present value

Indicate some of the problems associated with capital investment process.

Taj Mahal Tour Company proposes to invest $3 million in a new tour package project. Fixed costs are $1 million per year. The tour package costs $500 and can be sold at $1500 per package to tourists. This tour package is expected to be attractive for the next five years. If the cost of capital is 20%, what is the NPV break-even number of tourists per year? (Ignore taxes, give an approximate answer)

You have come up with the following estimates of project cash flows: The cash flows are perpetuities and the cost of capital is 8%. What does a sensitivity analysis of NPV (without taxes) show?

Option to abandon a project is a:

Why is sensitivity analysis less realistic than Monte Carlo Simulation?