Question

Again, your manager has tasked you with providing a recommendation regarding two alternative projects. You have identified the following two projects with the following characteristics:

                                                                        Project A                                Project B

CAPEX / Initial Outlay                                   $500,000                                 $300,000

Project life                                                       5 years                                     6 years

Revenue (per year)                                          $350,000                                 $250,000

Variable costs                                                 $90,000                                   $80,000

Operating expense                                          $60,000                                   $40,000

Investment in Net Working Capital (Year 0) $50,000                                   $30,000

The company’s tax rate is 30% and uses a straight-line depreciation method. There will be no ‘salvage’ value associated with these projects at the end of their project life. The company also anticipates it will recover all of the NWC at the end of the project. The company has a required rate of return of 13% per annum.

1. Determine the Free Cash Flows, for each year, to the firm for both projects.

2. Identify which project you recommend the company invest.

Using your own words, briefly describe how to use the techniques of sensitivity, scenario and simulation analyses to estimate project risk?

Answer 1