Please show full steps, will rate, thanks. 5. Brandt Enterprises is considering

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Please show full steps, will rate, thanks.

5. 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. WACC of the company = 11.5% Cash Flows (Dollars in Thousands) NPV Prob. X t= 0 t=1 t= 2 t= 3 NPV Prob. = 20% / $800.0 $800.0 $800.0 $938.10 $187.62 Prob. = 60% -$1,000 - $520.0 $520.0 $520.0 $259.76 $155.86 Prob. = 20% -$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

Obviously the CV of the project is more than the normal range of CV of 2 to 3 prescribed by the company for its projects, thereby highlighting the higher than acceptable risk of the project.

What the company should do is to apply risk adjusted required rate of return for evaluating the alternative project proposals. The premium for higher risk could be based on the CV of cash flows associated with the projects. A project should be accepted only if the NPV is positive with the risk adjusted required rate of return appropriate to it.

It also depends on whether the firm has other acceptable alternative projects on hand.

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