Review the example shown in Exhibit 11.2, p. 486. Conduct three independent sensitivity analyses as indicated next.

Exhibit 11.2

1. Compute the difference in the NPV of the alternatives if the minimum desired rate of return were 20 per cent instead of 14 per cent.

2. Compute the difference in the NPV of the alternatives if predicted cash operating costs of the new motor were £35,000 annually instead of £30,000, using the 14 per cent discount rate.

3. By how much may the annual cash operating savings fall short of the £10,000 predicted amount before the difference in NPV between the alternatives reaches zero? Use the original discount rate of 14 per cent?

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I. Total project approach A. Replace Recurring cash operating costs, using an annuity table* Disposal value, end of year 5 Initial required investment NPV of net cash flows B. Keep Recurring cash operating costs, using an annuity table* Overhaul, end of year 2 Disposal value, end of year 5 NPV of net cash flows Difference in NPV between the alternatives II. Differential approach A-B. Analysis confined to differences Recurring cash operating savings, using an annuity table* Overhaul avoided, end of year 2 Difference in disposal values, end of year 5 Incremental initial investment Difference in NPV between alternatives *Table B2, Appendix B. Present value discount factor at 14% 3.4331 .5194 1.0000 3.4331 .7695 .5194 3.4331 .7695 .5194 1.0000 Total present value £(102,993) 1,558 (31,000) £(132,435) £(137,324) (7,695) 4,155 £(140,864) £ 8,429 £ 34,331 7.695 (2,597) (31,000) £ 8,429 0 £(31,000) £(31,000) Sketch of after-tax cash flows at end of year 2 3 I I £(30,000) £(40,000) £ 10,000 £(30,000) £(40,000) £(10,000) £ 10,000 £ 10,000 £(30,000) £(40,000) £ 10,000 4 1 £(30,000) £(40,000) £ 10,000 5 1 £(30,000) £3,000 £(40,000) £ 8,000 £ 10,000 £ (5,000)