Question
Jonathan is the owner of a small construction company. He is thinking about purchasing some construction equipment; however, he knows that the economy will have
Jonathan is the owner of a small construction company. He is thinking about purchasing some construction equipment; however, he knows that the economy will have a major impact on his future cash flows. He is not quite sure what to do with the scenario data that his financial officer gave him, and he is looking for your advice.
Scenario Analysis | |||
| Worst Case | Most Likely | Best Case |
| 30% Probability | 50% Probability | 20% Probability |
Cost of Investment (Year 0) | 308,000 | 308,000 | 308,000 |
Year 1 Net Cash Flow | 62,500 | 84,500 | 92,500 |
Year 2 Net Cash Flow | 70,800 | 95,020 | 100,450 |
Year 3 Net Cash Flow | 84,600 | 102,500 | 114,800 |
Year 4 Net Cash Flow | 68,000 | 94,800 | 102,500 |
Year 5 Net Cash Flow | 54,500 | 76,000 | 86,400 |
Salvage value (end of year 5) | 12,000 | 26,000 | 38,000 |
You explain to him that the expected return of the project is the sum of the weighted expected returns from each scenario. Question 3.1 Does the project make sense if the cost of capital is 12%? Explain. Question 3.2 Does the project make sense if Jonathan demands an internal rate of return of 15%? Explain.
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