25. Information about the cash flows for a four-year financial project are liste
ID: 2813146 • Letter: 2
Question
25. Information about the cash flows for a four-year financial project are listed in the following table. The cash flows are assumed to follow a triangular distribution. The cost of implementing the project is expected to be between $60,000 and $70,000, with all values in this range being equally likely. Analysis of changes in the Consumer Price Index suggests that the annual rate of inflation can be approxi mated with a normal distribution with a mean of 4 percent and standard deviation of 1.5 percent. The organization's required rate of return is 20 percent. Develop a model in CB to analyze this situation and answer the following questions. Minimum Most Likely Maximum Inflow $15,000 $20,000 $30,000 $20,000 $25,000 35,000 $20,000 $30,000 $35,000 $40,000 $50,000 $60,000 ear Inflow Inflow (a) What is the expected NPV of this project? (b) What is the range of NPVs? (c) How would you characterize the level of risk associated with this project? (d) Would you recommend undertaking the project? Why or why not?Explanation / Answer
Answer a.
Most Likely Cash Flow
The formula to calculate the present value of future cash flow is : PV (rate, nper,pmt,FV)
By using Excel, we can calculate the present value.
Total Value of Future cash flow : 16666.67 + 17361.11 + 17361.11 + 24112.65 = 75501.54
Expected project Cost = (60000 + 70000) / 2 = 65000
The expected NPV = 75501.54 - 65000 = 10501.54
Answer b:
Minimum Cash flow
Total value of future cash flow = 12500 + 13888.89 + 11574.07 + 19290.12 = 57253.09
NPV = 57253.09 - 60000 = - 2746.91
Maximum Cash flow:
Total value of future cash flow = 25000 + 24303.56 + 20254.63 + 28935.19 = 98495.37
Maximum expected future cash flow = 70000
NPV = 98495.37 - 70000 = 28495.37
The range of NPV = -2746.91 to 28495.37
Answer c.
There are two type of risk is associated with this project:
1. If we consider the minimum cash inflow, then the NPV is coming negative, that means the future cash flow is not sufficient to overcome the minimum project cost associated with this project.
2. The actual value of future cash flow would be decreased due to the inflation. Therefore, the present value of all future cash flow would be less than what we have calculated above.
Answer d:
The recommendation to undertake the project depends on how cash flow is generating. If we consider the most likely cash flow, then the NPV is coming positive. Therefore we can consider this project. But if the NPV is negative (in case of minimum cash inflow), then the project should not be undertaken.
1 2 3 4 Cash flow 20000 25000 30000 50000 Required rate of return 20% 20% 20% 20% Present value of future cah flow 16666.67 17361.11 17361.11 24112.65Related Questions
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