You are an analyst working in the nance department of Branson Ltd. Branson is a public listed tour company that is based in Melbourne. One

You are an analyst working in the finance department of Branson Ltd. Branson is a public listed tour company that is based in Melbourne. One of its main operating businesses is to provide tourists with hot-air balloon flights over the city. As the current balloons are due to be retired, Branson must decide whether to replace them with a large or small model. New balloons have an expected life of 8 years, after which salvage values are $70,000 for the large balloons and $45,000 for the small balloons. Market research has estimated that there is a 60% probability that demand will be high throughout the useful life of the balloons, and a 35% probability that demand will be low throughout the useful life of the balloons. Lastly, the company decides to consider a 5% probability that it is unable to operate the hot-air balloon business at all due to legal constraints. The large model is expected to cost $700,000, with an extra installation and shipping costs of $50,000. The small model is expected to cost $450,000, with an additional installation and shipping costs of $45,000.

The company accounting's policy is to depreciate using the reducing balance approach of 20% per annum. There is also an initial increase in net working capital of $60,000 for the large model, and $30,000 for the small model. The net working capital is recoverable at the end of their useful life. In the event of high demand, the company expects a yearly operating revenue of $1,000,000 for the large model, and a yearly operating revenue of $450,000 for the small model. If the demand is low, yearly operating revenue is forecasted to be $400,000 for both the large model and thesemallmodel.

 Annualvariablecostsassociatedwithoperatingtheseballoonsareexpected to be 50% of the operating revenue for the large model and 45% of the operating revenue for the small model. In the event that the hot-air balloon business cannot be operated, the yearly operating revenue is to decrease to zero. Fixed operating costs associated with operating the large balloons are $100,000 per year, and that for small balloons are $65,000. In addition, if the large model is preferred over the small model, the company needs to rent an additional warehouse to store the large balloons. A new warehouse's rental cost is expected to be $100,000 per year. 

You have recently evaluated the capital structure of the company and believes that it is operating at the optimal level of 60% debt and 40% equity. The weighted average cost of capital (WACC) from this capital structure is 12.5%. You would also like to understand howsensitive your capital budgeting decisions are due to changes in WACC. As such, in addition to determining which model to invest, you want to investigate the effects of WACC on NPV and the cross-over rates of the large and small models when demands are high and when demands are low.

Required

Using Excel as your main analysis tool, evaluate whether the company should proceed with the purchase of large or small balloons, taking into consideration of the various scenarios. Please show (1) the various cash flows based on the different scenarios and (2) the sensitivity analysis using different WACC and the calculation of cross-over rates.