Aluminum Co is interested in the risk of a proposed investment and is looking for ways of
Question:
Aluminum Co is interested in the risk of a proposed investment and is looking for ways of incorporating risk into its investment assessment process. The company has heard that probability analysis can be helpful in this respect and therefore the following information has been prepared concerning the proposed investment:
Cash flow Probability Cash flow Probability
($) ($)
1,000,000 0.1 2,000,000 0.3
2,000,000 0.5 3,000,000 0.6
3,000,000 0.4 5,000,000 0.1
The company is not however sure how the results of the investment assessment can be interpreted on the basis of a probability analysis. The investment proposed will cost $3.5 million, payable in full at the beginning of the first year of operation. Aluminum Co uses a 12 percent discount rate in investment assessment.
Required:
(a) Use of common probability:
(i)Calculate the (expected) mean NPV of the investment proposed.
(ii) Calculate the likelihood of a negative NPV investment.
(iii) Calculate the most probable outcome of the NPV.
(iv) Comment on the financial admissibility of the investment proposed.
(b) Discuss TWO of the following risk adjustment and investment uncertainty
Assessment:
(i)simulation
(ii) Payback adjusted
(iii) Discount rates adjusted for risk
Statistics For Business And Economics
ISBN: 9780321826237
12th Edition
Authors: James T. McClave, P. George Benson, Terry T Sincich