Project Analysis You are discussing a project analysis with a coworker. The project involves real options, such as expanding the project if successful, or abandoning the project if it fails. Your coworker makes the following statement: “This analysis is ridiculous. We looked at expanding or abandoning the project in two years, but there are many other options we should consider. For example, we could expand in one year, and expand further in two years. Or we could expand in one year, and abandon the project in two years. There are too many options for us to examine. Because of this, anything this analysis would give us is worthless.” How would you evaluate this statement? Considering that with any capital budgeting project there are an infinite number of real options, when do you stop the option analysis on an individual project?
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Corporate Finance
- The Siler Construction Company is about to bid on a new industrial construction project. To formulate their bid, the company needs to estimate the time required for the project. Based on past experience, management expects that the project will require at least 24 months, and could take as long as 48 months if there are complications. The most likely scenario is that the project will require 30 months. a. Assume that the actual time for the project can be approximated using a triangular probability distribution. What is the probability that the project will take less than 30 months? b. What is the probability that the project will take between 28 and 32 months? c. To submit a competitive bid, the company believes that if the project takes more than 36 months, then the company will lose money on the project. Management does not want to bid on the project if there is greater than a 25% chance that they will lose money on this project. Should the company bid on this project?arrow_forwardWaste Management Inc. is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price will increase with inflation. Fixed costs will also be constant, but variable costs will rise with inflation. The project should last for 3 years, and there will be no salvage value. This is just one project for the firm, so any losses can be used to offset gains on other firm projects. What is the project's expected NPV? IRR? Would you accept this project? WACC 9.50% Net investment cost (depreciable basis) $100,000 Units sold 40,000 Average price per unit, Year 1 $25.00 Fixed op. cost excl. depr'n (constant) $150,000 Variable op. cost/unit, Year 1 $20.20 Annual depreciation rate 33.33% Expected inflation 5.00% Tax rate 40.0% Please show work.arrow_forwardYou are considering investing in a project related to a new product opportunity. If you undertake the project immediately, you calculate the NPV will be $165,000. If you postpone the decision for one year, you will learn more about the relevant manufacturing process as well as the market for your product. If you wait one year, you expect with 80 percent likelihood competitors will enter the market and your NPV (in one year) will be - $20,000. With 20 percent likelihood, you will be the only market player and you will improve your production technology to create an NPV (in one year) of $400,000. The appropriate discount rate is 11 percent. Required: Calculate the expected NPV if you defer the project for one year, regardless of the potential scenario. Calculate the expected NPV if you strategically decide how to undertake your project. That is, if we find that competitors enter the market, we can decide not to enter. Interpret the difference in your answers to parts 1 and 2.arrow_forward
- A firm has only $10,000 to invest and must choose between two projects. Project A returns $12,400 after a year while project B pays $15,609 after three years. If management wants to select the investment with the higher return, which alternative should be chosen? Calculate the return for each investment and indicate which option provides the higher return and explain why.arrow_forwardTwo new software projects are proposed to a young, start-up company. The Delta project will cost $150,000 to develop and is expected to have annual net cash flow of $40,000. The Echo project will cost $200,000 to develop and is expected to have annual net cash flow of $50,000. The company is very concerned about their cash flow. Using the payback period, which project is better from a cash flow standpoint? Why? Present the payback period for each project. Use this formula: Payback period = Investment/Annual Savingsarrow_forwardYour boss wants you to conduct a sensitivity and scenario analysis to determine whether the following project is a winner. You are entering an established market, and you know the market size will be 1,100,000 units. You are unsure of your exact market share, the price you will be able to charge, and your variable cost per unit, but have determined a range of possible values for each (in the table below). Your initial investment cost is $150 million, and that investment will depreciate in straight-line form over the 20-year life of the project. There are no new NWC requirements, and there will be no salvage value at the end of the 20 years. The tax rate is 35%. The discount rate is 18%. a) Use the following table to conduct a full sensitivity analysis for the project. Make sure to include the NPV for the expected outcome as part of the full sensitivity analysis. Also add the best- and worst-case scenarios to the full sensitivity analysis. Show all of your work (written out, not an…arrow_forward
- Mad Scientist, Inc. is considering investing into the nanotechnology business. After conducting a detailed due diligence process, the company's board decided that the current cost of entry into the nanotechnology business is too high. The board also thinks that the commercialization of technological advancements will eventually drive costs down and the company should get into the nanotech business one or two years from now, when they can realize a higher NPV on their investment. Given the above, the board has chosen the option to: Expand Abandon Delayarrow_forwardSuppose you are a panelist, and you must evaluate if the design is feasible or not. You look at the breakdown of expenses, possible revenues, etc. Here are some important chapters and discussions taken from a certain plant design. Chapter 3: Market Study This plant design, entitled “IIVSDROP: The First Ear Dropper Solution Manufacturing Plant in the Philippines” considers a 30-year period of study, starting 2021, after finishing its construction by 2020. All projections, and interest rates set by the company shall be evaluated within this 30-year period. The inflation rate shall not be included in the computation and a minimum attractive rate of return is set at 20%. Chapter 4: Products Our company produces ear dropper solution which can be sold for PHP. 125.00 per bottle. Annually, the company can produce 1000 pallets of the product. Each pallet is stacked with 14 layers and each layer consists of 8 boxes. A box contains 12 bottles of ear dropper for wholesale…arrow_forwardYou are the head of the project selection team at SIMSOX. Your team is considering three different projects. Based on past history, SIMSOX expects at least a rate of return of 20 percent. Given the following information for each project, which one should be SIMSOX's first priority? Should SIMSOX fund any of the other projects? (Use the NPV function in Excel to solve this problem. Negative amount should be indicated by a minus sign.) Project: Dust Devils Year Investment 460,000 0 1 2 3 Project: Ospry Year Investment 410,000 0 TEZLO 1 2 4 Project: Voyagers Revenue Stream 0 Year Investment 0 107,000 1244TO 3 5 40,000 330,000 430,000 Revenue Stream 0 78,000 78,000 78,000 99,000 Revenue Stream 0 47,000 25,000 82,000 66,000 134,000 The NPV for Dust Devils is The NPV for Ospry is The NPV for Voyagers is How many projects should be funded?arrow_forward
- As an staff at company, you are considering two projects which project A has an initial investment of $100,000 and yearly revenue of $17, 600 for 10 years, and Project B has an initial investment of $51,000 and yearly revenue of $10, 100 for 10 years. What is the point of indifference? Which project would you accept at a WACC of 16.0%? a) Point of indifference does not exist, accept project B b)Point of indifference at 8.60%, accept both Project A and Project B c) Point of indifference at 8.60%, don't accept Project A and don't accept ProjectB d) Point of indifference at 14.84%, accept Project B. e) Point of indifference at 11.86%, accept Project B f)Point of indifference at 11.86%, accept Project Aarrow_forwardDesai Industries is analyzing an average-risk project, and the following data have been developed. Unit sales will be constant, but the sales price should increase with inflation. Fixed costs will also be constant, but variable costs should rise with inflation. The project should last for 3 years, it will be depreciated on a straight-line basis, and there will be no salvage value. No change in net operating working capital would be required. This is just one of many projects for the firm, so any losses on this project can be used to offset gains on other firm projects. What is the project's expected NPV? 10.0% $200,000 39,000 $25.00 WACC Net investment cost (depreciable basis) Units sold Average price per unit, Year 1 Fixed op. costs excl. depr. (constant) Variable op. cost/unit, Year 1 Annual depreciation rate Expected inflation rate per year Tax rate Oa. -$64.886 Ob. -$66,833 Oc. -$72,673 O d. -$73,970 O e. -$60,993 $150,000 $20.20 33.333% 5.00% 40.0%arrow_forward4. Investment timing options Companies often need to choose between making an investment now or waiting until the company can gather more relevant information about the potential project. This opportunity to wait before making the decision is called the investment timing option. Consider the case: Tolbotics Inc. is considering a three-year project that will require an initial investment of $44,000. If market demand is strong, Tolbotics Inc. thinks that the project will generate cash flows of $29,000 per year. However, if market demand is weak, the company believes that the project will generate cash flows of only $2,000 per year. The company thinks that there is a 50% chance that demand will be strong and a 50% chance that demand will be weak. If the company uses a project cost of capital of 12%, what will be the expected net present value (NPV) of this project? (Note: Do not round intermediate calculations and round your answer to the nearest whole dollar.) -$7,111 O-$6,433 O-$7,788…arrow_forward
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