BRAC is considering investing $100000 in a new machine with an expected life of 5 years. The machine will have no scrap value at the end of the 5 years. It is expected that 20000 units will be sold each year at a selling prices of $6.00 per unit. Variable production costs are expected to $2.30 per unit, while incremental fixed costs, mainly the wages of a maintenance engineer, are expected to be $10000 per years. BRAC uses a discount rate of 11% for investment appraisal purposes and expects investment projects to recover their initial investment within two years.

Required:
(1) Explain why risk and uncertainty should be considered in the investment appraisal process.

(2) Calculate and comment on the payback period of the project.

(3) Evaluate the sensitivity of the projects net present value to a change in the following project variables:

a. Sales volume

b. Sales price

c. Variable cost

Discuss the use of sensitivity analysis as a way of evaluating project risk.

Answer rating: 100% (QA)

1 There are two main reasons why risk and uncertainty should be considered in the investment appraisal process First they can have a significant impac... View the full answer