12-3-Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier of
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Question
12-3-Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier of highly purified to semiconductors manufactures. 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 semiconductor 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 "customer" plant, which will cost $40 million to build. The custom will allow Blair to produce the highly specialized gases that are required for and emerging semiconductor manufacturing process. Blair estimates that its clients will order $10 million of product per year if the traditional plant is constructed, but if the customized is put in place, Blair expects to sell $15 million worth of products annually to it clients. Blair has enough money to build either type of plant, and in the absence of risk difference, accepts the project with the highest NPV. The cost of capital is 12%.
A)Find the NPV for each project. Are the projects acceptable? Show work.
B) Find the breakeven cash inflow for the project. Show work.
C) The firm has estimated the probabilities of achieving various ranges of cash inflow for the two projects as shown in the following table. What is the probability that each project will achieve at least the breakeven cash inflow found in part b?
Probability of achieving
Cash inflow in given range
Range of cash inflow ($ millions) Standard Plant Custom Plant
$0 to $5 0% 5%
$5 to $8 10 10
$8 to 11 60 15
$11 to 14 25 25
$14 to 17 5 20
$17 to 20 0 15
Above $20 0 10
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 wishes 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
The Net present value of both plants i.e. Standard and Custom, are as under:
Standard Plant: (Amount in $' million)
Custom Plant: (Amount in $' million)
(a) Both the projects have the positive NPV , BUT Project Custom have the higher NPV, so recommend Project Custome to choice.
(b) For both the projects, the Break Even cash flow point is 4th Year of their production.
(c) Probability of both Projects cash flow, the break even position will be:
Both Project will atleast achieve the Break Even in the 4 th year of their production.
(d) The Project Standard is more risky to Project Custom. So, the Project Custom has the potentially higher NPV.
The Risk-return trade-offs of the two projects, the Standard project is more risky as it has no probability to achieve the higher level sales targets. The Custom project is less risky as its probability to achieve the each range sales evenly.
(e) We will recommend Project Custom for both minimizing losses and to achieve a higher NPV.
year Product Sales/costs discount rate Net Present value of Sales cummulative NPV of sales 0 (30) (30) 1 10 1.12 8.92 8.92 2 10 1.25 8.00 16.92 3 10 1.40 7.14 24.06 4 10 1.57 6.37 30.43 (break even point) 5 10 1.76 5.68 36.11 NPV 6.11Related Questions
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