Exam 13: Risk Analysis and Project Evaluation

Random,unforeseeable events can have a significant impact on future cash flows.

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 Wollongong.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 not considered?

One type of real option is to delay the beginning of a project until conditions are more favourable.

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 considered?

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 number of croissants sold increases by 10%,and all other variables remain the same,how much will free cash flow increase?

Use the following information to answer the following question(s). Destroya Extermination Services projects next year's sales of its new X-Ray termite inspection service at 5,000 inspections priced at $175 each.The variable costs per inspection are expected to be $87.50.Fixed cash costs are expected to be $90,000 and depreciation $110,000.The company's marginal tax rate is 34%.Destroya 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 free cash flow for the best case scenario?

Chevre Imported Cheese forecasts that if sales revenue for next year is $1,250,000,net operating income will be $100,000 and if sales revenue is $1,000,000,net operating income will be $80,000.Chevre's degree of operating leverage is

Use the following information to answer the following question(s). Destroya Extermination Services projects next year's sales of its new X-Ray termite inspection service at 5,000 inspections priced at $175 each.The variable costs per inspection are expected to be $87.50.Fixed cash costs are expected to be $90,000 and depreciation $110,000.The company's marginal tax rate is 34%.Destroya 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 free cash flow if the most likely estimates are used?

One advantage of simulation is that it can differentiate between unsystematic and systematic risk.

Which of the following is a reason why risk analysis is an important part of capital budgeting?

Boulangerie Bouffard expects to sell 1.25 million croissants next year for $1.50 each.Variable cost of a croissant is $0.80.Fixed costs are $150,000,depreciation $200,000 and the tax rate is 34%.If the bakery can increase the price of a croissant to $1.75 sales will fall by 50,000 croissants.All other things equal,operating cash flow will increase or decrease

Forecasts for project ST are shown above.Using a discount rate of 10%,the project has a positive NPV of $6,074.69.Estimate within $100 the level of sales revenue that will result in an NPV of $0.00.No other variables will change.

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).

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

When evaluating projects with real options,businesses must consider the probability that the option will be exercised.

In capital budgeting decisions,simulation analysis gives a probability distribution only for cash flows.

A company that was most concerned about the impact of price changes in raw materials would use sensitivity analysis.

There is a 30% probability that an office building will be sold after 5 years for $30 million,a 50% probability that it will be sold for $20 million and a 20% probability that it will be sold for $10 million.What is the expected value of the office building in 5 years?

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)?

Variable cost for Light.com's fluorescent tubes is $12.50,and the tubes are sold over the internet to businesses and organizations for $20.00 each.Fixed costs are $7,500,000.What is the break-even quantity for the fluorescent tubes?