5. Brandt Enterprise the CFO set up the following table to show its three most l

Question

5. Brandt Enterprise the CFO set up the following table to show its three most likely scenarios. WACC of the company = 11.5% ash Flows (Dollars in Thousands NPV Prob. x NPV Prob. = 20% Prob. = 60% Prob, 2090 $187.62 $520.0 $520.0 $259.76 $155.86 $200.0 -$200.0 -$1,484.52 -$296.90 $800.0 $80 0.0 $938.10 $800.0 $520.0 -$200.0 -$1,000 Exp. NPV = $4651 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, hovw do you evaluate the project's risk level and further justify if the project is profitable?

Explanation / Answer

If the company undertakes this project there are 3 possibilities 1. Project will earn supernormal cash flows, probability of which is 20%

2. The project will earn normal cash flows, its probability is 60%

3. The project will be a failure with negative cash flows whose probability is 20%.

Outflow at t0 = 1000$

Scenario 1 Inflow is 800$ each year for 3 years.

Scenario 2. Inflow is 520$ for 3 years.

Scenario 3. Inflow is - 200$ for 3 years.

Expected NPV = 46.57$

Standard deviation is 179.87$

CV= 3.86$

This shows that the project is having substantial risk.

The best case scenario is the average one with greater probability.

If CV of company is 2.0 - 3.0 but the project is having CV of 3.86 which means the project is quite risky as it is having more fat distribution than what is tolerable.

The company still can take the project as it is having positive NPV

Related Questions

Navigate

• Browse (All)
• Browse 5
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.