Suppose the CFO wants you to do a scenario analysis with different values for th

Question

Suppose the CFO wants you to do a scenario analysis with different values for the cost savings, the machine's salvage value, and the net operating working capital (NOWC) requirement. She asks you to use the following probabilities and values in the scenario analysis:

Calculate the project's expected NPV, its standard deviation, and its coefficient of variation. Round your answers to two decimal places.

E(NPV) = $    

NPV = $    

CV =   

Scenario Probability Cost Savings Salvage Value NOWC Worst case 0.35 $72,000 $18,000 $30,000 Base case 0.35 $90,000 $23,000 $25,000 Best case 0.30 $108,000 $28,000 $20,000

Explanation / Answer

Worst-case scenario:

                                         0                1                2                3                4                5    

Initial investment    ($250,000)

Net oper. WC             (30,000)

Cost savings                                 $72,000   $ 72,000     $72,000     $72,000     $72,000

Depreciation                                 82,500   112,500     37,500     17,500                   0

Oper. inc. before taxes                ($10,500) ($ 40,500)    $34,500     $54,500     $72,000

Taxes (40%)                                  (4,200)   (16,200)    13,800     21,800     28,800

Oper. Inc. (AT)                           ($ 6,300) ($ 24,300)    $20,700     $32,700     $43,200

Add: Depreciationa                      82,500   112,500     37,500     17,500                   0

Oper. CF                                      $76,200   $ 88,200     $58,200     $50,200     $43,200

Return of NOWC                                                                                                $30,000

Sale of Machine                                                                                                     18,000

Tax on sale (40%)                                                                                                   (7,200)

Net cash flow         ($280,000)    $76,200   $ 88,200     $58,200     $50,200     $84,000

NPV = -$7,663.52

Base-case scenario:

This was worked out in part a. NPV = $37,035.13.

Best-case scenario:

                                         0                1                2                3                4                5    

Initial investment    ($250,000)

Net oper. WC             (20,000)

Cost savings                               $108,000   $108,000   $108,000   $108,000   $108,000

Depreciation                                 82,500   112,500      37,500      17,500                   0

Oper. inc. before taxes               $ 25,500 ($    4,500) $ 70,500   $ 90,500   $108,000

Taxes (40%)                                   10,200       (1,800)     28,200       36,200     43,200

Oper. Inc. (AT)                          $ 15,300 ($    2,700) $ 42,300   $ 54,300   $ 64,800

Add: Depreciationa                        82,500   112,500     37,500     17,500                   0

Oper. CF                                    $ 97,800   $109,800   $ 79,800   $ 71,800   $ 64,800

Return of NOWC                                                                                              $ 20,000

Sale of Machine                                                                                                     28,000

Tax on sale (40%)                                                                                                    (11,200)

Net cash flow         ($270,000) $ 97,800   $109,800   $ 79,800   $ 71,800   $101,600

NPV = $81,733.79

                              Prob.                     NPV           Prob. ´ NPV

Worst-case             0.35              ($ 7,663.52)    ($ 2,682.23)

Base-case               0.35               37,035.13      12,962.30

Best-case                0.30               81,733.79      24,520.14

                                                                  E(NPV) $34,800.21

sNPV     = [(0.35)(-$7,663.52 – $34,800.21)2 + (0.35)($37,035.13 – $34,800.21)2 + (0.30)($81,733.79 – $34,800.21)2]½

        = [$631,108,927.93 + $1,748,203.59 + $660,828,279.49]½

        = $35,967.     84.

CV = $35,967.84/$34,800.21 = 1.03.

*I assumed that initial investment is 250000 in this case as you didn't provided that.

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