Part 3: Risk analysis and project evaluation

3.1 Perform a scenario analysis on the data provided Case Study:

Assume that the company, where you are working as a team in Financial Department, is considering a potential project with a new product that is expected to sell for an average price of $22 per unit and the company expects it can sell 650 000 unit per year at this price for a period of 4 years. Launching this project will require purchase of a $3 500 000 equipment that has residual value in four years of $500 000 and adding $ 850 000 in working capital which is expected to be fully retrieved at the end of the project. Other information is available below:

Depreciation method: straight line

Variable cost per unit: $17

Cash fixed costs per year: $450 000

Discount rate: 10%

Tax Rate: 30%

QUESTIONS BELOW

Do a scenario analysis with cash flows of the assumed project to determine the sensitivity of the projects NPV to different scenarios that are defined in terms of the estimated values for each of the projects value drivers. Please work on two scenarios corresponding to the worst- and best-case outcomes for the project. You need to provide your results in (a) relevant tables:

Worst case: Unit sales decrease by 20%; price per unit decreases by 20%; variable cost per unit increases by 20 %; cash fixed cost per year increases by $100 000

Best case: Unit sales increase by 20%; price per unit increases by 20%; variable cost per unit decreases by 20%; cash fixed cost per year decreases by $100 000

Based on the scenario analysis outcome, draw relevant conclusion about project NPVs sensitivity.