Perform a scenario analysis creating a best case and a worst case in addition to the base case. The managers give you the following information.

The chief marketing officer (CMO) estimates that they will sell 400 units a year for 5 years at a price of $16,000 each. If they reduce the price to $15,000 each they can sell 472 units a year. He estimates the probability of this at 20%. However, if the public does not like their tankless water heaters they will only sell 100 units a year and will have to drop the price down to $12,000 apiece. He estimates the probability of this being 30%.

The chief operations officer (COO) estimates that the variable costs to build these will be 80% of revenue. If they can get the higher volumes, then he estimates the cost to be only 75%. But with the really low volumes the cost will be 85%.

The chief financial officer (CFO) says the company will use the MACRS 3 year class for depreciation. He estimates that the assembly line will have salvage value of $100,000. However, he notes that worst case there may be nothing to salvage and best case they could find a buyer willing to pay $140,000. He notes that AO Smiths tax rate is 33% and that the normal WACC is 11%. He notes that the WACC varies between 8% and 13%.

A scenario analysis changes only one variable at a time to determine where the biggest risk is.

a) True

b) False