Advanced: Sensitivity analysis A company is considering investing in a new manufacturing facility with the following characteristics:
Question:
Advanced: Sensitivity analysis A company is considering investing in a new manufacturing facility with the following characteristics:
A initial investment £350 000 - scrap value Nil;
B expected life 10 years;
C sales volume 20 000 units per year;
0 selling price £20 per unit;
E variable direct costs £15 per unit;
F fixed costs excluding depreciation £25000 per year.
The project shows an internal rate of return {IRR) of 17%. The managing director is concerned about the viability of the investment as the return is close to the company's hurdle rate of 15%. He has requested a sensitivity analysis.
You are required to:
{a) recalculate the internal rate of return (IRA) assuming each of the characteristics A to F above, in isolation, varies adversely by 10%; (12 marks)
(b) advise the managing director of the most vulnerable area likely to prevent the project meeting the company's hurdle rate; {6 marks)
(c) explain what further work might be undertaken to improve the value of the sensitivity analysis undertaken in (a);
{6 marks)
{d) re-evaluate the situation if another company, already manufacturing a similar product, offered to supply the units at £1 8 each - this would reduce the investment required to £25000 and the fixed costs to £10000.
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