Brandt Enterprises is considering a new project that has a cost of $1,000,000, a

Question

Brandt Enterprises is considering a new project that has a cost of $1,000,000, and the CFO set up the following table to show its three most likely scenarios. 5. WACC of the company-11.5% Prob, x NPV $187.62 Cash Flows (Dollars in Thousands) NPV $800.0 $938.10 Prob. = 20% Prob. = 60% Prob. = 20% $800.0 $800.0 1,000$520.0 $520.0 $520.0 $259.76 $155.86 $200.0 -$200.0 -$200.0 -$1,484.52 -$296.90 Exp. NPV = $46,57 Standard Deviation = 179.87 CV=3.86 If you were the CFO of this company, how do you explain this scenario analysis result? Knowing the CV of the average project of the company is in the range of 2.0 to 3.0, how do you evaluate the project's risk level and further justify if the project is profitable?

Explanation / Answer

The CV for this project conducted under the scenario analysis shows us that the CV is 3.86 which is much above the acceptable limit for the company which is between 2.0 and 3.0. So, the risk is very high for this project and much above the level of risk of the other projects in the company.

Although, this higher risk produces a higher profitability, the risk cannot be borne by the business as it has all other projects within the CV of 2.0 and 3.0 Hence keeping in mind, the risk averse nature of the business, I would recommend that this project should not be undertaken.

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