Ann called back to Sam just after lunch and mentioned that she had met with Hellen Johnson who is the
chairman of the company and Bruce Willis the CEO and got the message that Sam is expected in the
board room at 2PM. Here we go Sam muttered whilst he went for a cup of tee. The combination of Hellen
and Bruce usually indicated a lot of work.
At 2PM sharp Sam entered the board room and saw the concerned view of Hellen and Bruce.
Bruce started off presenting a short term project that some of the board members like the company to
pursue. The whole idea was to invest in a new product called the "wheat ventilator". "It is about to get
wheat to dry faster. Everyone knows that any business in the agricultural business is a hazard but this
might be an opportunity. The upfront investment is M 40 and that is not too much however the market
conditions for the upcoming year looks rather scary with a 30% chance for decline, 25% for normal and
45% for growth. The following year has only two conditions good or bad and for bad the probability is 45%
and for good the probability is 55%. The outcome during the first year shows a cashflow of M -10 for decline,
M 60 for growth and M 45 for normal. The second year is estimated to deliver a cashflow of M -5 for bad
and M 60 for good. Bruce continued with saying that the board estimates the return to be around M 25
meaning that this is a chance of a lifetime! What do you think?"
Sam took a deep breath and started by saying; That might be if you have no risk. Given the presentation
we need to use our base rate for investments at 7% an then another 8% for the additional risk. Then
I think we will be faced with a reasonable return but a totally unacceptable overall risk.
Bruce and Hellen did not like what they just heard and asked for a full analysis of this.
Help Sam to make an assessment of this ad present your view on whether this is something to go for?
Assume that cash flows are received in the end of each year and the investment is paid early year one.