Question
The directors of Alpha plc are considering setting up new manufacturing facilities for apparel in Cambodia. The company has spent 300,000 doing its market research
The directors of Alpha plc are considering setting up new manufacturing facilities for apparel in Cambodia. The company has spent 300,000 doing its market research and paying for licenses etc. to operate in the Cambodian market.
The factory will cost the company 32 million to set up and company operations will commence twelve months after the project has got underway. The funds towards the factory will only be paid once the site is ready for operations, i.e. in twelve months time. Management intend to run the company for three years, once operations commence. Thereafter, it will hand over the company to the local government for a nil reward.
Net cash flows the three years that the project is to be run are as follows:
Year | Estimated Net Cash Flow (ms) | Probability of Occurrence |
2 | 9 | 0.2 |
2 | 10 | 0.4 |
2 | 12 | 0.4 |
3 | 10 | 0.3 |
3 | 13 | 0.4 |
3 | 16 | 0.3 |
4 | 14 | 0.1 |
4 | 18 | 0.5 |
4 | 20 | 0.4 |
The cash flows estimated above are expected to be independent over time.
The risk free rate of interest is 8% and the company's cost of capital, 12%.
Required:
a. Calculate the expected net present value (ENPV) of the project above and determine whether it is worth the company's while.
b. Calculate the net present values (NPVs) of the best and the worst possible outcomes, together with their probabilities of occurrence.
c. Based on the figures above, the standard deviation of the project above is 2.5 million. A second proposal to set up manufacturing facilities in China has materialised. The ENPV and standard deviation of the NPV for this alternative have been computed at 1.2 million and 3.4 million respectively, and the NPV for the best and worst possible outcomes are 7 million and -7 million, respectively, with probabilities of occurrence of 0.1 and 0.05 respectively. Compare the two potential projects and explain which, if either, the company should go ahead with.
d. Alpha plc has just learnt that its financial position will enable it to undertake both projects. Given that the partial correlation coefficient between the Cambodian and Chinese projects is -0.3, determine whether the company should proceed with both projects.
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