Analyzing Risk

Use the following information to answer the next three questions:

Shrieves Casting Company is considering adding a new line to its product mix. The production line would be set up in unused space in the main plant, and the machinerys invoice price would be approximately $200,000, another $10,000 in shipping charges would be required, and it would cost an additional $30,000 to install the equipment. The machinery has an economic life of 4 years and will be depreciated straight line to zero over its 4 year life. The machinery is expected to have a salvage value of $25,000 after 4 years. The new line would generate incremental sales of 1,250 units per year for 4 years at an incremental cost of $100 per unit, excluding depreciation. Each unit can be sold for $200. Further, to handle the new line, the firm will have a one-time investment in net operating working capital equal to 12 percent of sales revenues. The firms tax rate is 40 percent, and its overall weighted average cost of capital is 10 percent. Use simulation with 1,000 iterations to find expected OCF and standard deviation of OCF. The probability distribution for unit sales, selling price per unit, and variable cost per unit are shown below.

4. (EXCEL TEMPLATE) If product acceptance is poor, unit sales would only be 900 units a year and the unit price would only be $160. A strong consumer response would produce sales of 1,600 units and a unit price of $240. What are your worst-case, base-case, and best-case scenarios for the NPV of the project?

5. (EXCEL TEMPLATE) Suppose that unit sales can vary from the base-case by 10, 20, and 30 percent. What is the sensitivity of the project OCF to changes in the unit sales?

6. (EXCEL TEMPLATE)

a. Use simulation with 1,000 iterations to find expected operating cash flow (OCF) and standard deviation of OCF. The probability distribution for number of units sold, selling price per unit, and variable cost per unit are shown below. PRINT ONLY THE FIRST PAGE OF THE SPREADSHEET

Unit sales	Probability	Selling Price	Probability	Variable Cost	Probability
875	0.05	$140	0.05	$70	0.05
1,000	0.10	$160	0.10	$80	0.05
1,125	0.15	$180	0.10	$90	0.10
1,250	0.40	$200	0.50	$100	0.45
1,375	0.15	$220	0.10	$110	0.15
1,500	0.10	$240	0.10	$120	0.10
1,625	0.05	$260	0.05	$130	0.10

b. Calculate the probability that the OCF will be negative.