MINI CASE

As a financial analyst at Glencolin International $($GI$)$ you have been asked to revisit your analysis

a two capital investment alternatives submitted by the production department of the firm.

$($Detailed discussion of these alternatives is in the Mini Case at the end of Chapter $10.)$ The CFO

is concerned that the analysis to date has not really addressed the risk in this project. Your task is

to employ scenario and sensitivity analysis to explore how your original recommendation might

change when subjected to a number of "what$-$ifs."

In your discussions with the CFO, the CIO, and the head of the production department, you have

pinpointed two key inputs to the capital budgeting decision: initial software development costs

and expected savings in production costs $($before tax$).$ By properly designing the contract for

software development, you are confident that initial software costs for each alternative can be

kept in a range of $+$ or $-15\%$ of the original estimates. Savings in production costs are less cer$-$

tain because the software will involve new technology that has not been implemented before. An

appropriate range of these costs is $+$ or $-40\%$ of the original estimates.

As the capital budgeting analyst, you are required to answer the following in your memo to the

CFO:

a$)$ Conduct sensitivity analysis to determine which of the two inputs has a greater input on the

choice between the two projects.

b$)$ Conduct scenario analysis to assess the risks of each alternative in turn. What are your

conclusions?

c$)$ Explain what your sensitivity and scenario analyses tell you about your original recommendations.

We recommend using a spreadsheet in analyzing this Mini Case.