CASE $3($continued$)$

The project team has estimated the following for unit sales,

selling price, variable cost per unit, and cash fixed operating

expenses for the best$-$case, worst$-$case, base$-$case scenar$-$

ios as follows:

a$.$ Estimate the cash flows for the investment under the listed

base$-$case assumptions. Calculate the project NPV for

these cash flows.

b$.$ Evaluate the NPV of the investment under the worst$-$case

assumptions.

c$.$ Evaluate the NPV of the investment under the best$-$case

assumptions.It's been six months since you started at Soya Feeds Plc as an as$-$

sistant manager in the finance department. During that time, you

were awarded a promotion and you are now a special analyst in

the team, reporting directly to the Director of Finance. You have

received a new assignment that expects you to conduct a risk

analysis. You have been asked to provide a recommendation on

the project and to respond to a number of questions aimed at

judging your understanding of risk analysis and capital budget$-$

ing. The memorandum you received outlining your assignment

is as follows:

TO: The Special Analyst, Finance

FROM: Mr$.$ G$.$ Burnham, CFO, Soya Feeds Plc

RE: Capital Budgeting and Risk Analysis

Please provide a written response to the following questions:

Explain how sensitivity analysis and scenario analysis are

useful tools for evaluating project risk?

What are real options? How does the presence of option$-$

ality in an investment that the firm makes cause the tradi$-$

tionally calculated NPV of a project to be underestimated?

Explain how simulations work. What is the value of using a

simulated approach?

How can break$-$even analysis be helpful in evaluating

project risk

What is sensitivity analysis, and what is its purpose?

Now that the management is confident in your skill set to

deliver on your responsibilities, the fimm would like you to

look at a new project. This project involves the acquisition

of a fully automated CNC machine to be used in our metal

works division. The initial outlay for this project is expected to

be $2,000,000$ and each unit of product manufactured with

this new technology is expected to sell for $300.$ The projec$-$

tions made by our experts suggest that we can sell $20,000$

units of these products per year for the next five years at this

price. The CNC machine will have a residual salvage value

of $200,000$ at the end of the project's five$-$year life. The firm

also expects to invest an additional $300,000$ in working

capital to support the new business. Consider the following

additional information:

CASE $3($continued$)$

The project team has estimated the following for unit sales,

selling price, variable cost per unit, and cash fixed operating

expenses for the best$-$case, worst$-$case, base$-$case scenar$-$

ios as follows:

a$.$ Estimate the cash flows for the investment under the listed

base$-$case assumptions. Calculate the project NPV for

these cash flows.

b$.$ Evaluate the NPV of the investment under the worst$-$case

assumptions.

c$.$ Evaluate the NPV of the investment under the best$-$case

assumptions.