Part E

Assume that you are confident about the estimates of all the variables that affect the cash flows except unit sales. If product acceptance is poor, sales would be only 65,000 units a year, while a strong consumer response would produce sales of 240,000 units. In either case, cash costs would still amount to 40% of revenues. You believe that there is a 35% chance of poor acceptance, a 15% chance of excellent acceptance, and a 50% chance of average acceptance (the base case). 1. What is the worst-case NPV? The best-case NPV? Hint: you should consider the 8% inflation in your calculation, i.e., part (E) is based on part (D). 2. Use the worst-case, most likely case (or base-case), and best-case NPVs with their probabilities of occurrence, to find the projects expected NPV, standard deviation, and coefficient of variation.

Part F

Assume that Allieds average project has a coefficient of variation (CV) in the range of 1.25 to 1.75. Would the lemon juice project be classified as high risk, average risk, or low risk? What type of risk is being measured here? Hint: calculate CV using results from part (E) then compare with the given range of 1.25 to 1.75.

Part (G) In recent months, Allieds group has begun to focus on real option analysis. What is real option analysis? Please give two examples of projects with embedded real options?