PROJECT RISK ANALYSIS USING SIMULATION Rayner Aeronautics is considering a

$12.5 million investment that has an estimated project free cash flow (Project FCF) of

$2 million in its first year of operations. The project has a five-year life, and Rayner requires a return of 18% in order to justify making the investment.

a. What rate of growth in Project FCF for Years 2 through 5 is required for the project to break even (i.e., have an NPV = 0)?

b. Construct a simulation model for the investment opportunity to estimate the expected values of the Project FCF for Years 1 through 5. The first year’s cash flow is normally distributed with an expected value of $2 million and a standard deviation of

$1 million. Moreover, the rate of growth in Project FCF for Years 2 through 5 follows a triangular distribution with the following parameter estimates:

Most Likely Growth Year Rate (ML) Minimum Growth Rate Maximum Growth Rate 2 40% 5 of ML 2 times ML 3 Actual growth rate for 5 the actual growth rate 2 times the actual growth the previous year for the previous year rate for the previous year

+ Actual growth rate for ; the actual growth rate 2 times the actual growth the previous year for the previous year rate for the previous year 5 Actual growth rate for 5 the actual growth rate 2 times the actual growth

c. What are the expected NPV and IRR for the project, based on your simulation the previous year analysis from part b?