Using the data from Example 6.1, let us assume that all the factors are known with certainty

(impossible in real life) except sales volume.

Extensive market research suggests that annual demand will be

● 4,000 units (0.2 probable), or

● 4,500 units (0.5 probable), or

● 5,000 units (0.3 probable).

What are the possible outcomes (in terms of NPV) and how probable is each one?

Data from Example 6.1

Greene plc has the opportunity to invest in a machine for the manufacture of a new product, the demand for which is estimated to be 5,000 units a year for five years. The business has made the following best estimates about the decision:
● The machine is estimated to cost £50,000 (payable immediately) and to have no residual value.
● The selling price per unit is planned to be £10.
● Labour and material costs are estimated to be £4 and £3 per unit, respectively.
● Overhead costs are not expected to be affected by the decision.
● The cost of capital for such a project is estimated to be 10 per cent p.a.
● The project is not expected to require any additional working capital.
● In the interests of simplicity, taxation will be ignored.
● Assume, also in the interests of simplicity, that all cash flows occur at year-ends.

(a) Assess the project (using NPV) on the basis of the above estimates.

(b) Carry out a sensitivity analysis of the above estimates.