In this project, you will compute the NPV (and IRR) of a cost cutting project. Specifically, a company is interested in acquiring new machinery to improve efficiency and obtain cost savings. The initial cost of the machinery is $1,750,000. There will be no impact on sales but costs will be reduced by $520,000. The tax rate is 21% and the salvage value is $100,000. There will be a net working capital injection at the beginning of the project at a rate of $50,000 to purchase additional inventory but inventory will revert to the original level when the project ends. The machinery will have a useful life of 5 years and it will fall into the MACRS 3-year class. The risk adjusted required rate of return on the project is 8%.

What is the NPV of the project?

Now, investigate the risk (uncertainty) of your NPV computations to different considerations.

First, conduct a sensitivity analysis of your NPV values by using Excel's One Variable Data Table. Specifically, compute sensitivity of NPV to savings, salvage value and discount rates. For each item, consider approximately 20% a (worst case), 10% less (worse case), 20% greater (best), 10% greater (better) relative to the expected (base) case. Which input is most critical for NPV?

Secondly, conduct a scenario analysis using Excel's Scenario Manager. Consider best, better, worse, worst case scenarios. What is your interpretation?