Basic Scenario Anaylysis P12-4 - Basic scenario Murdock Paints is in the process

Question

Basic Scenario Anaylysis

P12-4 - Basic scenario Murdock Paints is in the process of evaluating two mutually exclusive additions to the process capacity. The firms financial analyses have developed pessimistic, most likely and optimistic estimates of an annual cash inflows associated with cash projects. The estimates are shown in the following table.

Project A $8,400 Project B $8,400 Initial investment (CF0) Outcome Pessimistic Most likely Annual cash inflows (CF) $210 990 1,840 $930 990 1,140 imistic a. Determine the range of annual cash inflows for each of the two projects b Assume that the firm's cost of capital is 9.7% and that both projects have 15-year ves. Construct a table showing the NPVs or each project or each of the possible outcomes. Include the range of NPVs for each project. c. Do parts (a) and (b) provide consistent views of the two projects? Explain. d. Which project do you recommend? Why'?

Explanation / Answer

a)

Range = Highest value - Lowest value

b)

PROJECT A

PROJECT B

c)

Yes both the projects provide consistent view as the initial investment and the years of the project are same.

From the above we notice that project A is riskier than project B as the range is high for project A.

d)

If the company is interested to earn higher returns and willing to take up greater risk, then the company should select Project A as the NPV is higher than B. If the company is risk averse then select project B as the range or deviation is less.

Cash inflows Outcome Project A Project B Pessimistic 210 930 Most likely 990 990 Optimistic 1,840 1,140 Range = 1,630 210

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