Exam 13: Risk Analysis and Project Evaluation

Charles River Publishing's degree of operating leverage is .5. To increase net operating income from $3,750,000 to $3,937,500, it will need to increase sales from $25,000,000 to

Excom Fiberoptics is bidding on contracts to sell micro test tubes for biotechnology research. in sets of 1,000 tubes. Fixed costs including depreciation associated with the project are $2,000,000, variable cost per set is $16. Excom expects to sell 250,000 sets. What is the minimum price it can charge and reach the accounting break-even point?

What is the expected NPV of the project if the option to expand is considered?

What is the expected net operating profit after tax (NOPAT) for the best case scenario?

Garcia Developers will erect a small office building at a cost of $4,500,000. They have a client who will lease the space for 5 years at a price that will produce free cash flows of $150,000 per year. For approximately how much would they need to sell the building for at the end of the 5th year to reach break-even NPV? Garcia uses a discount rate of 10% for projects of this type.

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

Scenario analysis is the form of risk analysis

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

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

Cranston Plastic Packaging Solutions has run a simulation on a large project to produce eco-friendly packaging for personal hygiene products. The mean NPV is an impressive $8,000,000, but there is a 16% probability of a negative NPV and a 5% probability of an NPV worse than ($6,000,000).

A would be entrepreneur is considering buying a franchise from a national chain of fitness centers. Identify some of the risks she might face.

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.

Miniature Molding is planning to introduce a valve for use in medical implants. Variable costs per unit are $250. The maximum price MM could charge is $325. Fixed costs associated with this product are $20,000,000. The worst case forecast calls for sales of 240,000 valves, the best case for 290,400. Will MM reach accounting break-even in the worst case scenario?

What is the approximate five year survival rate for new businesses?

Real options are traded on both the American Exchange and Chicago Board Options Exchange (CBOE).

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?

Mork Pharmaceuticals believes that changes in health insurance may increase demand by as much as 10%, but also lower prices by as much as 10%. It is also concerned that the cost of materials may increase as much as 10% and the company may or may not be able to pass these higher costs on to its customers. To estimate expected, best case and worst case results, Mork should use

Briefly describe the 5 steps in performing a simulation analysis.

What is the expected NPV of the project if the option to abandon is considered?

Why is it important to perform risk analysis before accepting or rejecting major projects?