FIN 450 MODULE 2 PROBLEMSDOWNLOAD Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier of highly purified to semiconductors manufactures. A large chip producer has asked Blair to build a new gas production facility close to an existing semiconductor plant. Once the new gas plant is in place, Blair will be the excusive supplier for that semiconductor fabrication plant for the subsequent 5 years. Blair is considering one of two plant designs. The firsts �standard� plant which will cost $40 million to build. The custom will allow Blair to produce their highly specialized gases that are required for and emerging semiconductor manufacturing process. Blair estimates that its clients will order $10 million of product per year if the traditional plant is constructed, but if the customized is put in place, Blair expects to sell $15 million worth of products annually to it clients. Blair has enough money to build either type of plant, and in the absence of risk difference, accepts the project with the highest NPV. The cost of capital is 12%. A)Find the NPV for each project. Are the projects acceptable? B) Find the breakeven cash inflow for the project. C) The firm has estimated the probabilities of achieving various ranges of cash inflow for the two projects as shown in the following table. What is the probability that each project will achieve the breakeven cash inflow found in part b? Probability of achieving Cash inflow in given range Range of cash inflow ($ millions) Standard Plant Custom Plant $0 to $5 0% 5% $5 to $8 10 10 $8 to 11 60 15 $11 to 14 25 25 $14 to 17 5 20 $17 to 20 0 15 Above $20 0 10 d) Which project is more risky? Which project has the potentially higher NPV? Discuss the risk-return trade-offs of the two projects. e). If the firm wishes to minimize losses (that is, NPV < $0), which project would you recommend? Which would you recommend if the goal were to achieve a higher NPV? P12-4 Basic scenario Murdock Paints is in the process of evaluating two mutually exclusive additions to the process capacity. The firm�s financial analyses have developed pessimistic, most likely and optimistic estimates of an annual cash inflows associated with cash projects. The estimates are shown in the following table. Project-A Initial investments (CFo) Outcome -$8,000 Project-B -$8,000 Annual cash flow (CF) Pessimistic $200 $900 Most Likely 1,000 1,000 Optimistic 1,800 1,000 a). Determine the range of annual cash inflows for cash of the two operations b). Assume that the firms cost of capital is10% and that both projects have 20year lives. Construct a table similar to this one for the NPVs for each project. Include the range of NPVs for each project. c) Do parts a, and b provide consistent views of the two projects? Explain. d) Which project do you recommend? Why? P12-8 Risk adjustment discount rates; Basic Country Wallpaper is considering investing in one of three mutually exclusive projects, E, F, and G. The firms cost of capital, r is 15%, and the risk free rate is R, is10%. The firm has gathered the basic cash flow and risk index data for each project as shown in the following table. Projects r E Initial investment (CFo) -$15,000 F -$11,000 G -$19,000 Cash inflows (CFt) Years (t) 1 $6,000 $6,000 $4,000 2 6,000 4,000 6,000 3 6,000 5,000 8,000 4 6,000 2,000 12,000 Risk index (R1t) 1.8 1.00 0.60 a). Find the net present value (NPV) of each project using the firms cost of capital. Which project is preferred in this situation? b). The used the following equation ton determine the risk-adjusted discount rate RADR, for each project j: RADR j= Rf + [ RIj x (r � Rf) ] P12-12 Risk classes and RADR Moses Manufacturing is attempting to select the best of three mutually exclusive projects, X, Y, and Z. Although all the projects have 5-year lives, they possess different degrees of risk. Project X is class V, the highest risk class; project Y is II, the below average risk class; and project Z is class III, the average risk class. The basic cash flow data for each project and risk class and risk adjustment discount rates (RADRs) used by the firm are shown in the following tables. Project X Project Y Initial investment (CFg) Year (t) Project Z -$180,000 -$235,000 -$310,000 Cash inflows (CFt) 1 $80,000 $50,000 $90,000 2 $70,000 $60,000 $90,000 3 60,000 70,000 90,000 4 60,000 80,000 90,000 5 60,000 90,000 90,000 Risk Classes and RADRs Risk class Descriptions Risk-adjusted discount Lowest risk 10% rate (RADR) I II Below-average risk III Average risk IV Above average risk V 13 15 19 Highest risk 22 a) Find the risk adjusted NPV for each project. b) Which project if any, would you recommend that the firm undertake? P12-14 Unequal lives; ANPV approach Portland Products is considering the purchase of one of three manually exclusive projects for increasing production efficiency. The firm planes to use a 14% cost of capital to evaluate these equal risk projects. The initial investment and annual cash inflows over the life of each project are shown in the following table. Project X Project Y Initial investment (CFo) Project Z -$78,000 Year (f) -$52,000 -$66,000 Cash inflows (CFt) 1 $17,000 $28,000 2 25,000 38,000 $15,000 $15,000 3 33,000 _ $15,000 4 $41,000 _ $15,000 5 - - $15,000 6 - - $15,000 7 - - $15,000 8 - - $15,000 a) Calculate the NPV for each project over its life. Rank the project in descending order on the basis of NVP b) Use the annualized net present value (ANPV) approach to evaluate and rank the projects in descending order on the basis of ANPV. c)Compare and contrast your findings in parts a and b. Which project would you recommend? P12-18 Capital rationing; IRR and NPV Valley Corporation is attempting to select the best of a group of independent projects competing for the firms fixed capital budget of $4.5 million. The firms recognize that any unused portion of this budget will less then 15% cost of capital, thereby resulting in a present value of inflows, that that is less than the initial investment. The firm has summarized in the following table, the key data to be used in selecting the best group of projects. Projects Initial investments IRR A -$5,000,000 17% B -800,000 18 C -2,000,000 19 Present value of inflows at 15% $5,400,000 1,100,000 2,300,000 D -1,500,000 16 1,600,000 E -800,000 22 900,000 F -2,500,000 23 3,000,000 G -1,200,000 20 1,300,000 a) Use the internal rate of return (IRR) to select the best group of projects. b) Use the net present value (NPV) approach to select the best group of projects. c) Compare, contrast, and discuss your findings in parts a and b. d) Which project should the firm implement? Why?