Question 3 (Question C2 from 2019 semester 2 exam) You are an analyst for a financial services firm that was engaged one month ago to conduct sensitivity analysis on a new project for a client. Fortunately, the client is an alum of the University of Melbourne and has asked that the approach taught in Corporate Financial Decision Making be used. The project involves a contract with a high quality and low risk customer who has guaranteed that they will pay $60 per unit of the product to your client at the end of each of each of the eight years of the project's life. The 1 only uncertainty your client faces is how many units their customer will purchase (as determined by the quality of your item relative to competitors) and the variable cost per unit your client faces in producing the product with most of that variable cost being taken up by the cost of labour. You collect the following information. Variable Pessimistic estimate Expected Optimistic estimate Sales volume demanded 40,000 p.a. 60,000 80,000 Variable cost per unit $55 $40 $35 You also know that the project will require an initial investment of $500,000 at the commencement of the project and then another investment of $500,000 six months into the project. The required rate of return from the project is 13% p.a. (a) Utilising the principles discussed during class, provide a ranking of the variables from most to least important (show all workings). [5 marks] (b) Provide a plausible specific (i.e. real-world linked) explanation as to why the distance between the pessimistic and expected values of the variable cost per unit is not the same as the distance between the variable's optimistic and expected values. [3 marks] Question 3 (Question C2 from 2019 semester 2 exam) You are an analyst for a financial services firm that was engaged one month ago to conduct sensitivity analysis on a new project for a client. Fortunately, the client is an alum of the University of Melbourne and has asked that the approach taught in Corporate Financial Decision Making be used. The project involves a contract with a high quality and low risk customer who has guaranteed that they will pay $60 per unit of the product to your client at the end of each of each of the eight years of the project's life. The 1 only uncertainty your client faces is how many units their customer will purchase (as determined by the quality of your item relative to competitors) and the variable cost per unit your client faces in producing the product with most of that variable cost being taken up by the cost of labour. You collect the following information. Variable Pessimistic estimate Expected Optimistic estimate Sales volume demanded 40,000 p.a. 60,000 80,000 Variable cost per unit $55 $40 $35 You also know that the project will require an initial investment of $500,000 at the commencement of the project and then another investment of $500,000 six months into the project. The required rate of return from the project is 13% p.a. (a) Utilising the principles discussed during class, provide a ranking of the variables from most to least important (show all workings). [5 marks] (b) Provide a plausible specific (i.e. real-world linked) explanation as to why the distance between the pessimistic and expected values of the variable cost per unit is not the same as the distance between the variable's optimistic and expected values. [3 marks]
