Case: Allied Food Products is considering expanding into the fruit juice business with a new fresh lemon juice product. Assume that you were recently hired as assistant to the director of capital budgeting, and you must evaluate the new project. The lemon juice would be produced in an unused building adjacent to Allieds Fort Myers plant; Allied owns the building, which is fully depreciated. The required equipment would cost $250,000, plus an additional $30,000 for shipping and installation. In addition, inventories would rise by $20,000, while accounts payable would increase by $6,000. All of these costs would be incurred at t = 0. By a special ruling, the machinery could be depreciated under the MACRS system as 4-year property. The applicable depreciation rates are 45%, 30%, 15%, and 10%. The project is expected to operate for 4 years, at which time it will be terminated. The cash inflows are assumed to begin 1 year after the project is undertaken (t = 1), and to continue out to t = 4. At the end of the projects life (t = 4), the equipment is expected to have a salvage value of $35,000. Unit sales are expected to total 150,000 units per year, and the expected sales price is $1.50 per unit. Cash operating costs for the project (total operating costs less depreciation) are expected to total 55% of dollar sales. Allieds tax rate is 21%, and its WACC is 11%. Tentatively, the lemon juice project is assumed to be of equal risk to Allieds other assets. You have been asked to evaluate the project and to make a recommendation as to whether it should be accepted or rejected. To guide you in your analysis, your boss gave you the following set of tasks/questions:

Part (C)

1. What is sensitivity analysis?

2. How would you perform a sensitivity analysis on the unit sales, salvage value, and WACC for the project? Assume that each of these variables deviates from its base-case, or expected value by plus or minus 10%, 20%, and 30%. Explain how you would calculate the NPV, IRR, MIRR, and payback for each case.

3. What is the primary weakness of sensitivity analysis? What are its primary advantages?