Exam 13: Risk Analysis and Project Evaluation

Real options are derivative securities that derive their value from the value of the underlying projects.

When Quineboag Textile's sales revenue increased from $5.0 million to $5.25 million,net operation income increased from $500,000 to $575,000.What is Quineboag's degree of operating leverage (DOL)?

February sales for Ted's Variety Store equal $100,000,variable costs equal $60,000,fixed costs,including depreciation of $20,000,total $60,000.

Use the following information to answer the following question(s). An alternative energy project will cost $300,000.Depending on the price of electricity,the project will create after-tax savings of either $100,000 per year for 5 years or $75,000 per year for 5 years.If first year savings are only $75,000,the project can be sold at the end of the first year for $250,000.Use a discount rate of 10%. -What is the expected NPV of the project if the option to abandon is not considered?

Buffalo Drumsticks is evaluating a proposal to open a restaurant in Bermuda.The restaurant will cost $29 million to open.Expected cash flows are $8 million per year for the first five years.At the end of 5 years,the government of Bermuda will either revoke BD's permit and the restaurant will close,or renew the permit indefinitely.If the permit is revoked,the building and equipment can be sold for $10,000,000.If the permit is renewed,assume that the $8 million turns into a perpetuity.There is a 30% chance the permit will be revoked and a 70% chance it will be renewed.Compute the expected NPV of the project.Use a discount rate of 12%.

Dudster company's DOL is 2.If sales increase by 10%,NOI will increase by 5%.

The end result of a simulation analysis is

Economists at PHE Llc estimate a 20% probability of a recession next year,a 50% probability of an average economy,and a 30% probability of a rapid expansion.If there is a recession,the NPV of project O will be $20 million;if the economy is average,it will be $45 million and in case of a rapid expansion,it will be $75 million.What is the expected NPV of the project?

Use the following information to answer the following question(s). Orange Electronics projects sales of its new O-Phones for next year at 10,000 units priced at $150 each.The variable costs of an O-Phone are expected to be $75.Fixed cash costs are expected to be $150,000 and depreciation $100,000.The tax rate is 40%.Orange believes that any of its forecasts including fixed costs,but not depreciation or the tax rate which are known for certain,could be high or low by as much as 10%. -What is the expected net operating profit after tax (NOPAT)for the worst case scenario?

Enchanted Hearth expects to sell 1,200 wood pellet stoves in 2011 at an average price of $2,400 each.It believes that unit sales will grow between -5% and +5% per year and prices will rise or fall by as much as 5% per year.Forecast sales revenue for 2013 if the number of units sold increases by 5% per year and prices remain flat.

Use the following information to answer the following question(s). Tropical Soft Drinks is evaluating a proposal to install solar panels on the roof of its factory near San Juan.The panels will cost $150,000 per set.Depending on the price of electricity and the efficiency of the panels,the project will increase operating cash flows by either $50,000 per year or $75,000 per year.The useful life of the panels is 5 years.If early results indicate savings of $75,000 per year,four additional sets of panels will be installed immediately at the same cost with the same projected savings.The probability of either outcome is 50%.Use a discount rate of 10%. -What is the expected NPV of the project if the option to expand is considered?

The simulation approach provides us with

Briefly explain what is meant by a real option in capital budgeting.Give 2 concrete examples.

For a line of snowblowers sold by Arctic Equipment,fixed costs,including depreciation of $1,000,000,total $2,400,000.The snowblowers sell for $800 each.Variable costs of a snowblower are $500.Compute a.accounting break-even. b.cash break-even

Betty Gilmore plans to sell berry pies at a local farmer's market.The permit and space rental will cost her $2,000 for the June through August season.The pies will sell for $7.00.Ingredients and overhead average $4.00 per pie.She also has to pay five percent of her gross sales to the markets's organizers.How many pies will she need to sell to cover her fixed costs and realize a $3,000 profit?

DNATECH has developed a hair growth treatment at a cost of $10 million.They can license the technology to another company for a period of 10 years.What is the minimum annual free cash flow they could accept in order to reach break-even NPV on this product? Use a discount rate of 8%.

Miller River Light is evaluating a project that will require an initial investment of $350,000.Miller River uses a 12% discount rate for capital projects of this type.What level of operating cash flows over a period of 5 years will cause the project to reach break-even NPV? Assume cash flows come in the form of an end-of-the-year annuity.

Natick Nurseries has used scenario analysis to evaluate the purchase of a former dairy to use for nursery stock.The best case scenario produced a very favorable NPV of $4,000,000;the NPV of the most likely case was $2,000,000,but the worst case scenario resulted in an NPV of $(3,000,000)which would bring the company close to bankruptcy.Natick could improve its decision by

________ is a risk analysis technique in which the best- and worst-case net present values are compared with the project's expected net present value.

Boulangerie Bouffard expects to sell 1 million croissants next year for $1.25 each.Variable cost of a croissant is $0.75.Fixed costs are $150,000,depreciation $200,000 and the tax rate is 25%.If the bakery can increase the price of a croissant to $1.50 and all other variables remain the same,free cash flow will increase by