Wondering if someone could answer all questions in part 6 of attached image plea

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Wondering if someone could answer all questions in part 6 of attached image please - I'm doing finals prep and cant find solution !

Mini-Case It's been four months since you took a position as an assistant fi- 6· Now that they are comfortable with your skills your boss analyst at Caledonia Products. During that time, you've would like you to look at a new project. This new project had a promotion and you are now working as a special assistant involves the purchase of a new plasma outing foor te for capital budgeting, reporting directly to the CEO. Your latest can be used in its metal works division. The products assignment involves the analysis of several risky projects. Be- manufactured using the new technology are expected to cause this is your first assignment dealing with risk analysis, youse have been asked not only to provide a recommendation on the company analyst performing the analysis expects the projects in question, but also to respond to a number of ques- fim can sell 20,000 units per year at this price for a tions aimed at judging your understanding of risk analysis and period of five years capital budgeting. The memorandum you received outlining the purchase of a $2 million piece of equipment that has your assignment follows: TO: The Special Assistant for Capital Budgeting FROM: Mr. V. Morrison, CEO, Caledonia Products RE: Capital Budgeting and Risk Analysis for an average price of $300 per unit, and the a residual or salvage value in five years of $200,000. h addition, the firm expects to have to invest an additional $300,000 in working capital to support the new business. Other pertinent information conceming the business venture is provided below: Initial cost of equipment Project and equipment life Salvage value of equipment Working capital requirement Depreclation method Depreciation expense Discount rate or required rate of return Tax rate $2.000,000 5 years $200,000 $300,000 Straight Line $360,000 12% 30% Povide a written response to the following questions 1. Explain how sensitivity analysis and scenario analysis are useful tools for evaluating project risk 2. What are real options? How does the presence of optionality in the investments that firms make cause the traditionally calculated NPV of a project to be underestimated? 3. Explain how simulation works. What is the value of using 4How can breakeven analysis be helpful in evaluating 5. What is sensitivity analysis and what is its purpose? a simulation approach? In addition, estimates for unit sales, selling price, variable cost per unit, and fixed cash operating expenses for the base-case, worst-case and best-case are described below project risk? Expected or Base-Case Worst-Case Best-Case 15,000 250 210) (450,000) 25,000 330 (180) (350,000) 360,000 20,000 Unit sales Price per unit Variable cost per unit Cash fxed costs per year De $300 (500,000) $360,000 b. Evaluate the NPV of the investment under the worst a. Estimate the cash flows for the investment under the case assumptions provided above base-case or expected value assumptions listed c. Evaluate the NPV of the investment under the best- above. Calculate the project NPV for these cash lows. case assumptions provided above.

Explanation / Answer

Solution.

Calculation of Outflow

Calculation of present value of annuity @12% for 5 years

(Calculation in simple steps)

Ordinary Annuity [1/(1+n/100)]

(n = rate of interest 12%)

ANNUITY

[1/(1/1.12)]

[1/(1/1.12*1.12)]

[1/(1/1.12*1.12*1.12)]

[1/(1.12*1.12*1.12*1.12)]

[1/(1.12*1.12*1.12*1.12*1.12)]

CASH FLOW CALCULATION UNDER BASE CASE, WORST CASE AND BEST CASE

Variable cost (Sales units * variable cost per unit)

Assuming sales units are equal to production

30% = $63000

(Assuming Company has other income hence tax benefit will be taken on loss)

Company has other income since it is new product of the company there will be several other revenue generating segments of company

($147000)

Present value of salvage value of Equipment

(Salvage value * Annuity of 5th year)

($200000 * 0.5674)

Present value of realizable value of working capital

(Assuming the 100% realisation since nothing is given in question about it)

(Realisable value of working capital * annuity value of 5th year)

($300000 * 0.5647)

NET PRESENT VALUE

(present value of ALL cash inflow - cash outflow

Particulars Amount Cost of equipement $2000000 Working capital requirement $300000 Total Outflow $2300000

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