1. Assume that sales price will increase by the 4 percent inflation rate beginning after Year 0 (i.e. sales price is $2.00 per unit at Year 0 and $2.08 at Year 1- the end of first year). However, cash operating costs will increase by only 2 percent annually from Year 0. For simplicity, assume that no other cash flows are affect by inflation. Estimate the project's cash flows each year during the next four years by including cannibalization effect but excluding consideration of the cash flows associated with use of the building. What are the project's NPV, ITT, MIRR and payback? (Hint: use Excel Template as guide)

1. a. Why should firms be concerned with the riskiness of individual projects?
   1. (1) What are the three types of risk that are normally considered in capital budgeting?

(2) Which type of risk is most relevant? Why?

(3) Which type of risk is easiest to measure?

1. a. What is sensitivity analysis?
   2. Complete the sensitivity analysis table in the Excel Template, assuming initially that the project has average risk. Assume that each of these variables can deviate from its base case, or expected value, by plus or minus 10 percent, 20 percent, and 30 percent.
   4. Prepare a sensitivity diagram (this part is optional and you don't have to do it) and discuss the results.
   6. What are the primary weakness of sensitivity analysis? What are its primary advantages?

1. Complete the scenario analysis in Excel Template. Use the worst-case, base-case (most likely), and best-case NPVs, and their probabilities of occurrence, to find the project's expected NPV, standard deviation, and coefficient of variation. Is this project an average-risk project, or a low-risk project, or a high-risk project?

1. Based on the risk level of the project to determine the appropriate cost of capital (the discount rate to be used to estimate NPV), then calculate the project's risk-adjusted NPV. Should the project be accepted? What if it had a coefficient of variation (CV) of NPV of only 0.15 and was judged to be a low-risk project?

Answer rating: 100% (QA)

Answer Project Cash Flow Analysis with Inflation and Cannibalization Project Setup This analysis considers a project with increasing sales price due to inflation and increasing cash operating costs du... View the full answer