P12-3 Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier o
ID: 2651208 • Letter: P
Question
P12-3 Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier of highly purified gases to semiconductor manufacturers. A large chip producer has asked Blair to build a new gas production facility close to an existing semiconductor plant. Once the new gas plant is in place, Blair will be the exclusive supplier for that semiconduc tor fabrication plant for the subsequent 5 years. Blair is considering one of two plant designs. The first is Blair's standard" plant, which will cost $30 million to build. The second is for a custom" plant, which will cost $40 million to build. The custom plant will allow Blair to produce the highly specialized gases that are required for an emerg- ing semiconductor manufacturing process. Blair estimates that its client will order $10 million of product per year if the traditional plant is constructed, but if the cus- tomized design is put in place, Blair expects to sell $15 million worth of product annu- ally to its client. Blair has enough money to build either type of plant, and, in the absence of risk differences, accepts the project with the highest NPV. The cost of capital is 12% a. Find the NPV for each project. Are the projects acceptable? b. Find the breakeven cash inflow for each project c. The firm has estimated the probabilities of achieving various ranges of cash in flows for the two projects as shown in the following table. What is the probability that each project will achieve at least the breakeven cash inflow found in part b? Probability of achieving cash inflow in given range Range of cash inflow (s millions) Standard Plant Custom Plant $0 to $5 0%. 5% $5 to $8 10 $8 to $11 60 15 $11 to $14 25 $14 to $17 20 $17 to $20 15 Above $20 d. Which project is more risky? Which project has the potentially higher NPV? Discuss the risk-return trade-offs of the two projects e. If the firm wished to minimize losses (that is, NPV $0), which project would you recommend? Which would you recommend if the goal were to achieve a higher NPV?Explanation / Answer
Answer
a)
Standard Plant
Figures in Millions $
Year
Investment
Revenue
Cash flow
Disc rate -12%
Present value
A
B
C
D
C*D
A+B
0
-30
0
-30
1
-30
1
0
10
10
0.89
8.93
2
0
10
10
0.80
7.97
3
0
10
10
0.71
7.12
4
0
10
10
0.64
6.36
5
0
10
10
0.57
5.67
NPV
6.05
Custom Plant
Figures in Millions $
Year
Investment
revenue
Cash flow
Disc rate -12%
Present value
A
B
C
D
C*D
A+B
0
-40
0
-40
1
-40
1
0
15
15
0.89
13.39
2
0
15
15
0.80
11.96
3
0
15
15
0.71
10.68
4
0
15
15
0.64
9.53
5
0
15
15
0.57
8.51
NPV
14.07
Answer : NPV is positive So projects are acceptable.
b)
Break even cash inflow means present value of cash inflow is equal to present value of cash outflow of project
Figures in Million $
Break even cash inflow
Amount
Standard Plant
30
Custom Plant
40
c)
Standard Plant
Figures in Million
Year
Investment
Revenue
Cash flow
Disc rate -12%
Present value
A
B
C
D
C*D
A+B
0
-30
0
-30
1
-30
1
0
8
8
0.89
7.14
2
0
8
8
0.80
6.38
3
0
8
8
0.71
5.69
4
0
8
8
0.64
5.08
5
0
8
8
0.57
4.54
NPV
-1.16
Standard Plant
Figures in Million
Year
Investment
Revenue
Cashflow
Disc rate -12%
Present value
A
B
C
D
C*D
A+B
0
-30
0
-30
1
-30
1
0
11
11
0.89
9.82
2
0
11
11
0.80
8.77
3
0
11
11
0.71
7.83
4
0
11
11
0.64
6.99
5
0
11
11
0.57
6.24
NPV
9.65
Custom Plant
Figures in Millions
Year
Investment
revenue
Cash flow
Disc rate -12%
Present value
A
B
C
D
C*D
A+B
0
-40
0
-40
1
-40
1
0
11
11
0.89
9.82
2
0
11
11
0.80
8.77
3
0
11
11
0.71
7.83
4
0
11
11
0.64
6.99
5
0
11
11
0.57
6.24
NPV
-0.35
Custom Plant
Figures in Millions
Year
Investment
revenue
Cashflow
Disc rate -12%
Present value
A
B
C
D
C*D
A+B
0
-40
0
-40
1
-40
1
0
14
14
0.89
12.50
2
0
14
14
0.80
11.16
3
0
14
14
0.71
9.96
4
0
14
14
0.64
8.90
5
0
14
14
0.57
7.94
NPV
10.47
Figures in Million $
Break even cash inflow
Amount
Probability for achievement
Standard Plant
30
30% (25+5)
Custom Plant
40
45% (20+15+10)
d)
Standard plant project is more risky because it has only 30% probability of achieving breakeven cash inflow compared to custom plant has 45% probability of achieving breakeven cash inflow.
Custom plant has NPV of $ 14.07 million (with 45% probability) compared to standard plant has NPV of $ 6.05 million (with 30% probability). So Custom plant has potential higher NPV.
e)
If firm wished to minimise losses , then I would recommend custom project because it has higher probability(45%) of achieving break even cash inflow compared to standard project (30%).
Custom plant has NPV of $ 14.07 million compared to standard plant has NPV of $ 6.05 million. So I will recommend Custom plant.
Standard Plant
Figures in Millions $
Year
Investment
Revenue
Cash flow
Disc rate -12%
Present value
A
B
C
D
C*D
A+B
0
-30
0
-30
1
-30
1
0
10
10
0.89
8.93
2
0
10
10
0.80
7.97
3
0
10
10
0.71
7.12
4
0
10
10
0.64
6.36
5
0
10
10
0.57
5.67
NPV
6.05
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.