412 BFT Risk and Conce Looking toward further iwwth, Nielsen 1 year if the store was unsuccessful Both and Andersen decided they would have to partners agreed to study the alternatives expand outside of the Springtield area enne over the weekend and to make They decided on Oakllilla suburbs in An- a decision on Monday desca's old sales territory. The primary From the past experience and ober appeal of this location was that Andersen various Nielsen Andersen helieved Lucw the area and market better than any the big risks in opening a more of this other. Andersen would run the new come pe occurred in the first year. They pro while Nielse would stay the old store jecretales in the second year to be dou- They decided to evaluate the expansion bir dose in the first year and predicted opportunity using a 1yeur borizon style de growth beyond that. For purposes of changes or balance of payments pobles analysis, the partners decided to concen could end their business trate on two cases with regard to first-year A descloper was in the OCCAS of build sales: weak and successful. Weak sales ing some store space that would be within would be $250.00%) the first year, and str- the right vent range for a furniture store. cascal sales would be $600,000. The prob Space could be had for $10 per que abilities were estimated to be.7 for suc Loot per year, and all year lease was re- cons and for weak sales. quired. Nielsen arki Audit could can The primary up front were promu cel the leaseauty time, but there would tion and miscellaneous exposes of xe a penalty of 20 percent of the main $20,XII without the warehouseansembly ing lease payments. The location looked space and $50,000 with the warehouse good, but the question was how much awetly space. These expenses would re space to rent sult in an intimcdiatc 28 percent tax sar- Nieison and Andersen atzeed that ins Inventory would cost $200,000 with 10.01 square feet was the uplita sales the warehouse/assembly area and space. Andersen was in favor of takinly $100,000 without. It was estimated that the 15,000 square feet of spruce su lacy would eventory could be liquidated at cost if or have: 5.2001) i Peretur i storage and when the store was closed There would be Sentya kite. Nielsen wanted to take no accents receivable Lese mexe cus- a une crise ative approach using weekly tomers uscd credit cards, and arrange- cirupshipments from the Springfield locaments would be made with a finance com tion to deliver inventory to Oak Hill. The pany for those needing credit. Ochet distance was over 500 miles, and this would current assets and current liabilities would add approximately 15 percent to the cost of als be negligible. Depreciation and non- that turninure, but risk would be reduced cash expenses would be minimal, so in substantially, and the need for 5.000 square come and cash flow would he the same fect of sixace rould be climinated As a general guideline. Nielsens and Art- Andersen pointed out that if the store dersen estimated a text of goods sold with was successful, they woulil quite likely lind on-site assentbly at 60 percent of sales. thelves facing the necessity of buying Other variable costs would be 10 percent of their way out of the lost within 2 years to sales. They canimated fixed mis other than get warehouse and assembly space. An rent of 1 a year for every square foot of year lease oni 15,000 square feet would space in either sales space or warehouse/ prubably cont S12 a square foot by then. assembly space. The partners faced 28 per Nielen was more concerned about buying cent tax rates and used a 10 percent re out of :: 15,000-square-fool lease after quired return in their analysis. Chapter 12 Single Investment Risk Analy 413 Case Questions 1. Computea net income break ever point for the smaller and larger facilities. Find the sales level (after the first year) that will result in a net present value of $0. Remember that sales the first year will be hall of those after the first year. 3. Prepare a decision tree analysis of the alternatives 4. l'repare a graphical sensitivity analysis showing the relationship between sales level and nel present value for cac si k all ver Titive, 5. Should they lease space of 10,000 > 15.000 square feet Why? SELECTED REFERENCES Aggarwal, Raj. and Luc A, Siwenen. "Project Exit Value as a Measure of Flexibility and Risk Exposure." Angoney cowowi 31 (Fall 1989: 39-64. Arnold, Tom, and Richard L. Shockley, Jr. "Value Creation at Anheuser-Busch: A Real Options Example. Jinreol of Applied Corporate Finance 14 (Summer 2002):52-61. Bjerksund, Petter, anel Steiner Ekern, Managing Investment Opportunities under Price Uncertainty: From Last Chance to 'Walt and See Strategies. Financial Management 19 (Autumn 1990): 65-58 Chiu, Chui-Yi, and Chan S. Park Fuzzy Cash Flow Analysis Using Presene Worth Criterion. Engineering Los 90 / Winter 1991: 113-13 Eschenhach. Ted G., and Robert J. Gimpel. "Stochastic Sensitivity Analysis." Ex- Bering Boom 5 (Summer 1990: 305-322. Eschbenbach, Ted G. and Iisa SM. Kegie. "Exposition on Using Graphs for Sensitivity Anasis." Vinginering Economist 34 Summer 1989): 313-335 Cerchak, Yigal, and Thomas Astebro. "Calculating the Expectation and Variance of the Present Value for a Random Plit Stream of Uncertain Duration." 7% Enging Francais 45 #4 (2000):339-349 TIeri, David B. "Investment Policies That Pay Off," Ivan Business Review "Risk Analysis in Capital Povestment." Hana Business Reviea Hurley, WJ.-On the Use of Martingalees in Monte-Carlo Approaches to Multi period parameter Uncertainty in Capital levestment Risk Analysen (January February 1968) 96-108. January February 1964: 95-106, ginering from 43 a 2 Winter 1998): 189-199. Hurley, w...and 1. D. Johnson, Capital forestment under Uncertainty Car lating the present Value of the Depreciation Tax Shiek When the Tax Rate Incinering hawwisi 41 (Spring 1996): 243-251. diak. "Capital Asset Valuation and Deprecia wist 412 BFT Risk and Conce Looking toward further iwwth, Nielsen 1 year if the store was unsuccessful Both and Andersen decided they would have to partners agreed to study the alternatives expand outside of the Springtield area enne over the weekend and to make They decided on Oakllilla suburbs in An- a decision on Monday desca's old sales territory. The primary From the past experience and ober appeal of this location was that Andersen various Nielsen Andersen helieved Lucw the area and market better than any the big risks in opening a more of this other. Andersen would run the new come pe occurred in the first year. They pro while Nielse would stay the old store jecretales in the second year to be dou- They decided to evaluate the expansion bir dose in the first year and predicted opportunity using a 1yeur borizon style de growth beyond that. For purposes of changes or balance of payments pobles analysis, the partners decided to concen could end their business trate on two cases with regard to first-year A descloper was in the OCCAS of build sales: weak and successful. Weak sales ing some store space that would be within would be $250.00%) the first year, and str- the right vent range for a furniture store. cascal sales would be $600,000. The prob Space could be had for $10 per que abilities were estimated to be.7 for suc Loot per year, and all year lease was re- cons and for weak sales. quired. Nielsen arki Audit could can The primary up front were promu cel the leaseauty time, but there would tion and miscellaneous exposes of xe a penalty of 20 percent of the main $20,XII without the warehouseansembly ing lease payments. The location looked space and $50,000 with the warehouse good, but the question was how much awetly space. These expenses would re space to rent sult in an intimcdiatc 28 percent tax sar- Nieison and Andersen atzeed that ins Inventory would cost $200,000 with 10.01 square feet was the uplita sales the warehouse/assembly area and space. Andersen was in favor of takinly $100,000 without. It was estimated that the 15,000 square feet of spruce su lacy would eventory could be liquidated at cost if or have: 5.2001) i Peretur i storage and when the store was closed There would be Sentya kite. Nielsen wanted to take no accents receivable Lese mexe cus- a une crise ative approach using weekly tomers uscd credit cards, and arrange- cirupshipments from the Springfield locaments would be made with a finance com tion to deliver inventory to Oak Hill. The pany for those needing credit. Ochet distance was over 500 miles, and this would current assets and current liabilities would add approximately 15 percent to the cost of als be negligible. Depreciation and non- that turninure, but risk would be reduced cash expenses would be minimal, so in substantially, and the need for 5.000 square come and cash flow would he the same fect of sixace rould be climinated As a general guideline. Nielsens and Art- Andersen pointed out that if the store dersen estimated a text of goods sold with was successful, they woulil quite likely lind on-site assentbly at 60 percent of sales. thelves facing the necessity of buying Other variable costs would be 10 percent of their way out of the lost within 2 years to sales. They canimated fixed mis other than get warehouse and assembly space. An rent of 1 a year for every square foot of year lease oni 15,000 square feet would space in either sales space or warehouse/ prubably cont S12 a square foot by then. assembly space. The partners faced 28 per Nielen was more concerned about buying cent tax rates and used a 10 percent re out of :: 15,000-square-fool lease after quired return in their analysis. Chapter 12 Single Investment Risk Analy 413 Case Questions 1. Computea net income break ever point for the smaller and larger facilities. Find the sales level (after the first year) that will result in a net present value of $0. Remember that sales the first year will be hall of those after the first year. 3. Prepare a decision tree analysis of the alternatives 4. l'repare a graphical sensitivity analysis showing the relationship between sales level and nel present value for cac si k all ver Titive, 5. Should they lease space of 10,000 > 15.000 square feet Why? SELECTED REFERENCES Aggarwal, Raj. and Luc A, Siwenen. "Project Exit Value as a Measure of Flexibility and Risk Exposure." Angoney cowowi 31 (Fall 1989: 39-64. Arnold, Tom, and Richard L. Shockley, Jr. "Value Creation at Anheuser-Busch: A Real Options Example. Jinreol of Applied Corporate Finance 14 (Summer 2002):52-61. Bjerksund, Petter, anel Steiner Ekern, Managing Investment Opportunities under Price Uncertainty: From Last Chance to 'Walt and See Strategies. Financial Management 19 (Autumn 1990): 65-58 Chiu, Chui-Yi, and Chan S. Park Fuzzy Cash Flow Analysis Using Presene Worth Criterion. Engineering Los 90 / Winter 1991: 113-13 Eschenhach. Ted G., and Robert J. Gimpel. "Stochastic Sensitivity Analysis." Ex- Bering Boom 5 (Summer 1990: 305-322. Eschbenbach, Ted G. and Iisa SM. Kegie. "Exposition on Using Graphs for Sensitivity Anasis." Vinginering Economist 34 Summer 1989): 313-335 Cerchak, Yigal, and Thomas Astebro. "Calculating the Expectation and Variance of the Present Value for a Random Plit Stream of Uncertain Duration." 7% Enging Francais 45 #4 (2000):339-349 TIeri, David B. "Investment Policies That Pay Off," Ivan Business Review "Risk Analysis in Capital Povestment." Hana Business Reviea Hurley, WJ.-On the Use of Martingalees in Monte-Carlo Approaches to Multi period parameter Uncertainty in Capital levestment Risk Analysen (January February 1968) 96-108. January February 1964: 95-106, ginering from 43 a 2 Winter 1998): 189-199. Hurley, w...and 1. D. Johnson, Capital forestment under Uncertainty Car lating the present Value of the Depreciation Tax Shiek When the Tax Rate Incinering hawwisi 41 (Spring 1996): 243-251. diak. "Capital Asset Valuation and Deprecia wist