Question 2:

Assume the following about a 6-year project: Mean Std Dev Sales Growth 5% 2% COGS/Sales 40% 15% Fixed Cost: $4,000 NWC as % of Sales: 12% Tax Rate: 35% Cost of Capital: 13% Sales for the first year will be $12,500, but the sales in subsequent years are uncertain. Estimated sales growth is assumed to be normally distributed with a mean of 5% and a standard deviation of 2%. Costs of goods Sold (COGS) each year are uncertain as well but are assumed to be a percentage of sales. COGS as a percentage of sales is assumed to be distributed normally with a mean of 40% and a standard deviation of 15%. Fixed costs will be $4,000 per year. The project will require an initial investment in net working capital of $500. Beginning at year 1, NWC is 12% of sales. The entire NWC investment (across all years) will be recovered at the end of the project. To operate the project, a new piece of equipment must be purchased at a cost of $15,000. The equipment will be depreciated using the straight-line approach (depreciate over 6 years, no salvage value). The cost of capital for this project is 13%. Tasks: a) Calculate the NPV of the project while capturing the uncertainty in sales and costs of goods sold. b) Simulate the NPV 500 times using a data table. c) Graph the frequency distribution of the NPV estimates; calculate the mean NPV and standard deviation. d) What is the probability that the NPV is positive? What is your recommendation for the project? Why?