Basic scenario analysis Murdock Paints is in the process of evaluating two mutua
ID: 2767224 • Letter: B
Question
Basic scenario analysis Murdock Paints is in the process of evaluating two mutually exclusive additions to its processing capacity. The firm's financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows associated with each project. These estimates are shown in the following table. a. Determine the range of annual cash inflows for each of the two projects. b. Assume that the firm's cost of capital is 10% and that both projects have 20-year lives. Construct a table similar to this one for the NPVs for each project. 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 of Cash Flows From $ To $ Project A 200 1,800 Project B 900 1,100 b NPV & Range Project A Period PV Factor @10% Cash Flow Pessimistic Cash Flow Most Likely Cash Flow optimistic PV of Cash Flow Pessimistic PV of Cash Flow Most Likely PV of Cash Flow optimistic Year 0 1 (8,000) (8,000) (8,000) (8,000) (8,000) (8,000) 1 0.909 200 1,000 1,800 182 909 1,636 2 0.826 200 1,000 1,800 165 826 1,488 3 0.751 200 1,000 1,800 150 751 1,352 4 0.683 200 1,000 1,800 137 683 1,229 5 0.621 200 1,000 1,800 124 621 1,118 6 0.564 200 1,000 1,800 113 564 1,016 7 0.513 200 1,000 1,800 103 513 924 8 0.467 200 1,000 1,800 93 467 840 9 0.424 200 1,000 1,800 85 424 763 10 0.386 200 1,000 1,800 77 386 694 11 0.350 200 1,000 1,800 70 350 631 12 0.319 200 1,000 1,800 64 319 574 13 0.290 200 1,000 1,800 58 290 521 14 0.263 200 1,000 1,800 53 263 474 15 0.239 200 1,000 1,800 48 239 431 16 0.218 200 1,000 1,800 44 218 392 17 0.198 200 1,000 1,800 40 198 356 18 0.180 200 1,000 1,800 36 180 324 19 0.164 200 1,000 1,800 33 164 294 20 0.149 200 1,000 1,800 30 149 268 NPV for the scenarios (6,297) 514 7,324 NPV & Range Project B Period PV Factor @10% Cash Flow Pessimistic Cash Flow Most Likely Cash Flow optimistic PV of Cash Flow Pessimistic PV of Cash Flow Most Likely PV of Cash Flow optimistic Year 0 1 (8,000) (8,000) (8,000) (8,000) (8,000) (8,000) 1 0.909 900 1,000 1,100 818 909 1,000 2 0.826 900 1,000 1,100 744 826 909 3 0.751 900 1,000 1,100 676 751 826 4 0.683 900 1,000 1,100 615 683 751 5 0.621 900 1,000 1,100 559 621 683 6 0.564 900 1,000 1,100 508 564 621 7 0.513 900 1,000 1,100 462 513 564 8 0.467 900 1,000 1,100 420 467 513 9 0.424 900 1,000 1,100 382 424 467 10 0.386 900 1,000 1,100 347 386 424 11 0.350 900 1,000 1,100 315 350 386 12 0.319 900 1,000 1,100 287 319 350 13 0.290 900 1,000 1,100 261 290 319 14 0.263 900 1,000 1,100 237 263 290 15 0.239 900 1,000 1,100 215 239 263 16 0.218 900 1,000 1,100 196 218 239 17 0.198 900 1,000 1,100 178 198 218 18 0.180 900 1,000 1,100 162 180 198 19 0.164 900 1,000 1,100 147 164 180 20 0.149 900 1,000 1,100 134 149 164 NPV for the scenarios (338) 514 1,365 Range of NPV From $ To $ Project A (6,297) 7,324 Project B (338) 1,365 c Part a & B are consistent as both Cash Flows and NPV ranges of Project A varies widely, whereas those of Project B are within medium range of deviation. d I woul recommend Project B. The Most Likely NPV is same for both , but the risk of lower range NPV is quite high is Project A . So it is better to minimize the risk .
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