Finance

a) Incremental cash flow.

Incremental cash flow refers to the firm’s cash flow with the project minus the firm’s cash flow without the project.

1)

The cash flow ought to exclude intrigue cost or profits. The return required by the investors outfitting the capital is as of now represented when we apply the 10% cost of capital discount rate; consequently, including financing flows would be double counting. Put another way, in the event that we deducted capital expenses in the table, and accordingly reduce the main issue money streams, and afterward discounted that CFs by the cost of capital, we would, essentially, be subtracting capital costs twice.

2)

The $100,000 cost to rehabilitate the production line site was incurred last year, and presumably also expensed for tax purposes. Since, it is a sunk cost; it should not be included in the analysis.

3)

If the plant space could be leased out to another firm, then if Shrieves accepts this project, it would forgo the opportunity to receive $25,000 in annual cash flows. This represents an opportunity cost to the project, and it should be included in the analysis. Note that the opportunity cost cash flow must be net of taxes,

l)

If a project affects the cash flows of another project, this is an externality which must be considered in the examination. On the off chance that the association's deals would be reduced by $50,000, then the net cash flow loss would be a cost to the project. Take note of that this yearly misfortune would not be the full $50,000, in light of the fact that Shrieves would save money on money working expenses if its deals dropped. Note that externalities can be certain and also negative.

b)

The depreciation rates from table 13-2 in the book.

c. the table below shows annual sales revenues and costs (other than depreciation).

The cost of capital is a nominal cost in includes a premium for inflation.

This is the bigger than the real cost of capital. Essentially, nominal cash flows are bigger than real cash flows. In the event that one rebates the low, real cash flows with the high, nominal rate, then the subsequent NPV is too low. Hence, discount nominal rate with a nominal rate, and genuine money streams with a genuine rate.

Calculating after-tax salvage cash flow

For this project, the after-tax salvage cash flow is:

Salvage Value $25,000

Tax On Salvage Value (10,000)

Net After-Tax Salvage Cash Flow $15,000

Calculate the annual sales revenues and costs (other than depreciation). With an inflation rate of 3%, the annual revenues and costs are: Here are the annual operating cash flows (in thousands of dollars):

i) Here are the three types of project risk:

· Stand-alone risk

Refers to the project’s total risk if it were operated independently. This type of risk ignores both the firm’s diversification among projects and investors’ diversification among firms.

· Within-firm risk

Refers to the total riskiness of the project which considers the firm’s other projects, that is, to diversification within the firm. It is the contribution of the project to the firm’s total risk, and it is a function of;

· the project’s standard deviation of NPV and

· the correlation of the projects’ returns with those of the rest of the firm.

· Market risk

Refers to the riskiness of the project to a well-diversified investor; this type of risk considers the diversification which is inherent in stockholders’ portfolios. It is measured by the project’s market beta, which is the slope of the regression line formed by plotting returns on the project versus returns on the market.

j) The sensitivity data are given here in tabular form (in thousands of dollars):

k) What is scenario analysis?

This is the analysis that examines several possible situations, usually worst case, and as well as the best case.

Best scenario: 1,600 units @$240

Worst scenario: 900 units @$160

l) There are problems with the scenario analysis

· It only considers a few possible out-comes

· Assumes that inputs are perfectly correlated –all “bad “ values occur together and all “good’ values occur together

· It focuses on stand-alone risk, although subjective adjustments can be made.

Primary weaknesses of simulation analysis

· It does not reflect diversification

· Ignores relationships among variables.

l) What is simulation analysis?

This is the computerized version of scenario analysis which applies continuous probability distributions.

Primary advantages

It reflects the probability distributions of each input

It gives an intuitive graph of the risk situation

Disadvantages

It is difficult to specify probability distributions and correlations

If inputs are bad, output will be bad.

m)

This will result in greater risk because steeper sensitivity lines indicate greater risk. Small changes result in declines in NPV.

No it should not be accepted because unit sales lines are steeper than salvage value.

Yes there are subjective risks to be considered for instance sales forecast. So for this particular project, should worry most about accuracy of sales forecast.

n) Real option

Refers to the right but not an obligation to execute certain business initiatives, such as deferring, increasing or expanding or contracting a capital investment project.

Types of real options

The flexibility availability to management for instance the actual real options which generally relate to project size, project timing and the entire operation of the project once established.

References

Paul G. Keat, Philip K.Y Young & Stephen E. Erfle (2008) Capital Budgetting and Risks.