Question

	Project A	Project B
Initial investment (CF0)	$12,600	$12,600
Outcome	Annual cash inflows (CF )
Pessimistic	$810	$1,590
Most likely	1,610	1,610
Optimistic	2,490	1,770

Basic scenario analysis  

Prime Paints is in the process of evaluating two mutually exclusive additions to its processing capacity. The firm's financial analysts have developed pessimistic, most likely, and optimistic estimates of the annual cash inflows associated with each project. These estimates are shown in the following table.

a. Determine the range of annual cash inflows for each of the two projects.

b. Assume that the firm's cost of capital is 9.5% and that both projects have 17-year lives. Construct a table showing the NPVs for each project for each of the possible outcomes. 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?

a. The range of annual cash inflows for project A is $nothing.(Round to the nearest dollar.)

Answer 1

a)

Range refers to the difference between the highest and lowest values of the outcomes

• Project A

Range of annual casflows = 2490 - 810 = $1680

• Project B

Range of annual casflows = 1770 - 1590 = $180

b)

Net present value (NPV) = Present value of cash flows - Initial investment

Present value of cash flows = CF *(1+ (1 / (1+r)^n) ) / r

CF = Cash flow

r = cost of capital = 9.5%

n = number of years = 17

Scenerios	PV of Cash flows (Project A)	PV of Cash flows (Project B)
Pessimistic	810 *(1+ (1 / (1+0.095)^17) ) / 0.095 = 6703.59	1590*(1+ (1 / (1+0.095)^17) ) / 0.095 = 13158.89
Most likely	1610*(1+ (1 / (1+0.095)^17) ) / 0.095 =13324.42	1610*(1+ (1 / (1+0.095)^17) ) / 0.095 =13324.42
Optimistic	2490*(1+ (1 / (1+0.095)^17) ) / 0.095 =20607	1770*(1+ (1 / (1+0.095)^17) ) / 0.095 = 14648.58

Scenerios	NPV (Project A)	NPV (Project B)
Pessimistic	= 6703.59 - 12600 = -5896	= 13158.89-12600= 558.89
Most likely	= 13324.42-12600= 724.42	= 13324.42-12600= 724.22
Optimistic	= 20607-12600= 8007	=14648.58-12600= 2048.58

Range pf NPV

Project A	Project B
= 8007 -(-5896) = 13903	=2048.58 - 558.89 = 1489.69

c)

As shown by both a and b Project A has higher range than Project B . Project A is tend to perform worst in pessimistic situation , while it will perform best in an optimistic situation.

d)

If i am risk averse manager i will go for project B as it is providing positive NPV in all 3 scenerios . But a manager who is willing to take risk will choose Project A.