Exam 10: Project Analysis

Petroleum Inc.(PI)controls offshore oil leases.It is considering the construction of a deep-sea oil rig at a cost of $500 million.The price of oil is $100/bbl.and extraction costs are $50/bbl.PI expects costs to remain constant.The rig will produce an estimated 1,200,000 bbl.per year forever.The risk-free rate is 10% per year,which is also the cost of capital.(Ignore taxes).Suppose that oil prices are uncertain and are equally likely to be $120/bbl.or $80/bbl.next year.Calculate today's NPV of the project if it were postponed by one year.

Adding a fudge factor to the cost of capital will penalize longer-term projects more due to compounding.

Monte Carlo simulation is likely to be most useful:

Which of the following does NOT represent an option to abandon a project?

You obtain the following data for year 1: Revenue = $43; Variable costs = $30; Depreciation = $3; Tax rate = 30%.Calculate the operating cash flow for the project for year 1.

A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0).You expect the project to produce sales revenue of $120,000 per year for three years.You estimate manufacturing costs at 60% of revenues.(Assume all revenues and costs occur at year-end,i.e.,t = 1,t = 2,and t = 3.)The equipment depreciates using straight-line depreciation over three years.At the end of the project,the firm can sell the equipment for $10,000 and also recover the investment in net working capital.The corporate tax rate is 30% and the cost of capital is 15%.What is the NPV of the project if the revenues were higher by 10% and the costs were 65% of the revenues?

The Solar Calculator Company proposes to invest $5 million in a new calculator-making plant that will depreciate on a straight-line basis.Fixed costs are $2 million per year.A calculator costs $5 per unit to manufacture and sells for $20 per unit.If the plant lasts for three years and the cost of capital is 12%,what is the accounting break-even level of annual sales? (Assume no taxes.)

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 three years (starting next year,i.e.,at t = 1).If it fails,you will only have net cash flows of $10 million per year for two years (also 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,i.e.,at t = 1.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 value of the abandonment option.(The discount rate is 10%.)

Petroleum Inc.(PI)controls off-shore oil leases.It is considering the construction of a deep-sea oil rig at a cost of $500 million.The price of oil is $100/bbl.and extraction costs are $50/bbl.PI expects costs to remain constant.The rig will produce an estimated 1,200,000 bbl.per year forever.The risk-free rate is 10% per year,which is also the cost of capital.(Ignore taxes).Suppose that oil prices are uncertain and are equally likely to be $120/bbl.or $80/bbl.next year. Suppose that PI has the option to postpone the project by one year.Calculate the value of the real option to postpone the project for one year.

A project requires an initial investment of $150.Your research generates the following estimates of revenues and costs: The cost of capital equals 10%.Assume that the cash flows occur in perpetuity.What does a sensitivity analysis of NPV (without taxes)show? (Answers appear in order: [Pessimistic,Most Likely,Optimistic].)

The following are drawbacks of sensitivity analysis EXCEPT:

A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0).You expect the project to produce sales revenue of $120,000 per year for three years.You estimate manufacturing costs at 60% of revenues.(Assume all revenues and costs occur at year-end,i.e.,t = 1,t = 2,and t = 3.)The equipment depreciates using straight-line depreciation over three years.At the end of the project,the firm can sell the equipment for $10,000 and also recover the investment in net working capital.The corporate tax rate is 30% and the cost of capital is 12%. Calculate the NPV of the project:

After completing a project analysis,an analyst should rely on which tool to make a final recommendation on the project?

A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0).You expect the project to produce sales revenue of $120,000 per year for three years.You estimate manufacturing costs at 60% of revenues.(Assume all revenues and costs occur at year-end,i.e.,t = 1,t = 2,and t = 3.)The equipment depreciates using straight-line depreciation over three years.At the end of the project,the firm can sell the equipment for $10,000 and also recover the investment in net working capital.The corporate tax rate is 30% and the cost of capital is 15%.Calculate the NPV of the project:

Generally,postaudits are conducted for large projects:

The Financial Calculator Company proposes to invest $12 million in a new calculator-making plant.Fixed costs are $3 million per year.A financial calculator costs $10 per unit to manufacture and sells for $30 per unit.If the plant lasts for four years and the cost of capital is 20%,what is the break-even level of annual sales? (Assume that revenues and costs occur at the end of each year.Assume no taxes.)Round to the nearest 1,000 units.

A project has an initial investment of 100.You have come up with the following estimates of the project's cash flows: Suppose the cash flows are perpetuities and the cost of capital is 10%.What does a sensitivity analysis of NPV (no taxes)show? (Answers appear in order: [Pessimistic,Most Likely,Optimistic].)

Which of the following simulation outputs is likely to be most useful and easy to interpret? The output shows the distribution(s)of the project's:

A project requires an initial investment in equipment of $90,000 and then requires an initial investment in working capital of $10,000 (at t = 0).You expect the project to produce sales revenue of $120,000 per year for three years.You estimate manufacturing costs at 60% of revenues.(Assume all revenues and costs occur at year-end,i.e.,t = 1,t = 2,and t = 3.)The equipment depreciates using straight-line depreciation over three years.At the end of the project,the firm can sell the equipment for $10,000.The corporate tax rate is 30% and the cost of capital is 16.5%.Calculate the NPV of the project.

Which of the following statements most appropriately describes scenario analysis?