Essay on Net Present Value and Capacity Planning

1269 Words Nov 3rd, 2012 6 Pages
CAPACITY PLANNING

Real Options Analysis Practice Questions and Solutions

CAPACITY PLANNING
Question 1: PROJECT SABLE Use a 30% per year discount rate to evaluate Project Sable, which has two phases. You may invest in the first, in both or in neither. You may not invest in the second phase without investing in the first.  Phase 1 requires an investment of $100. One year later the project delivers on the average $120.  At that time, after the phase 1 payout has been received, you may invest an additional $100 for phase 2. One year later, phase 2 pays out on the average $140. However, phase 2`s payout can go up or down by 20%. a. How much would Project Sable be worth if it offered only the phase 1 opportunity? b. How much would
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Phase-1 Year Net-cash-flow PV @ 5% NPV Alternative-1 Year Net-cash-flow PV @ 5% NPV Alternative-2 Year Net-cash-flow PV @ 5% NPV

CAPACITY PLANNING

0 -300 -300 -7.48 0 0 45.37 0

1 10 9.52

2 12 10.88

3 15 12.96

4 15 12.34

5 15 11.75

6 15 11.19

7 15 10.66

8 15 10.15

9 10 15 315 9.67 193.38

1 0

2 0

3 -240 -207.32

4 10 8.23

5 12 9.40

6 15 11.19

7 15 10.66

8 15 10.15

9 10 15 315 9.67 193.38

1

2

3

4

5

6 -235 -175.3

7 10 7.11

8 12 8.12

9 10 15 315 9.67 193.38

42.92
Phase1+ Alternative-1 Phase 1+ Alternative-2

-7.48+45.37

-7.48+42.92

A1>A2

Question 2: Suppose that discount rate is 5% and volatility is 20%. (c) Do you prefer Alternative 1 or 2 based on real options method? Decide whether the launch of new product is profitable or not based on real options valuation?
Alternative-1 Year Revenue Investment

CAPACITY PLANNING

0

1

2

3 -240

4 10

5 12

6 15

7 15

8 15

9 15

10 315

Options valuation of Alternative-1:

Real Options S = PV(Revenue) X = PV(Investment) A=S/X B = SQRT(T) * sigma

23% of S 

=58.12 252.69 207.32 1.22 0.35

Question 2: Suppose that discount rate is 5% and volatility is 20%. (c) Do you prefer Alternative 1 or 2 based on real options method? Decide whether the launch of new product is profitable or not based on real options valuation?

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