Exam 10: Project Analysis

Expansion options generally show as an asset on a corporation's balance sheet.

Most firms keep track of the progress of projects by conducting postaudits shortly after the projects have begun to operate.

Monte Carlo simulation is likely to be most useful

The option to wait is a type of abandonment option.

A project has an initial investment of 100.You have come up with the following estimates of the project's cash flows (there are no taxes): Pessimistic Mast Likely Optimistic Revenues 15 Costs 10 8 5 Suppose the cash flows are perpetuities and the cost of capital is 10 percent.Conduct a sensitivity analysis of the project's NPV to variations in revenues.(Answers appear in order: [Pessimistic, Most Likely, Optimistic].)

Postaudits are conducted before the start of projects.

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 percent 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 percent and the cost of capital is 16.5 percent.Calculate the NPV of the project.

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 percent 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.(There is some rounding in the answer.)

The following are real options except

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 percent).You will not know whether it is a hit or a failure until after 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 the discount rate is 10 percent, calculate Hillary's NPV.

KMW Inc.sells finance textbooks 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 three years.What is the economic or NPV break-even number of books that must be sold each year given a discount rate of 12 percent?

Firms with higher fixed costs tend to have higher degrees of operating leverage.

You calculate the following estimates of project cash flows (there are no taxes): Pessimistic Mast Likely Optimistic Investment 100 80 60 Revenues 30 40 50 Costs 20 15 10 The revenues and costs occur in perpetuity.The cost of capital is 8 percent.Conduct a sensitivity analysis of the project's NPV to variations in costs.(Answers appear in order: [Pessimistic, Most Likely, Optimistic].)

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

Discuss the importance of conducting postaudits.

You obtain the following data for year 1: Revenue = $43; variable costs = $30; depreciation = $3; tax rate = 30 percent.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 percent 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 percent and the cost of capital is 15 percent.Cash flows from the project are

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 percent, what is the accounting break-even level of annual sales? (Assume no taxes.)

Monte Carlo simulation is a tool intended to consider all possible combinations of variables.

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 prices and costs to remain constant.The rig will produce an estimated 1,200,000 bbl.per year forever.The risk-free rate is 10 percent per year, which is also the cost of capital.(Ignore taxes).Calculate the NPV to invest today.