Question

The CFO of a regional manufacturer has been happy with its performance over the last couple years.

Key performance parameters are as follows: Production Growth Rate: 15% Unit Sale Price: $1,100/unit Raw Material & Labor Cost: $800.00/unit MARR 18%

She believes the Monte Carlo forecasted NPVs are stable as designed. The chart shows a high probability for profits (~ 75%), and for strong profits, greater than $1,000,000 (~ 40%).

Recent economic events have caused the CFO to revise two key parameters. Revise Base Production Growth Rate down to 13% (from 15%) Revise MARR up to 20% (from 18%)

A. In 25 words or less each, describe the individual impacts upon NPV you expect to see as a result of: 1. Going to a Base Production Growth Rate of 13% (from 15%) 2. Adjusting MARR to 20% (from 18%)

B. In 25 words or less each, based upon the changes made in Part A, what type of market changes is the CEO likely expecting? Specifically address why would the CFO make each of the changes; be VERY specific (you must discuss at least THREE (3) scenarios the CFO could be facing).

Answer 1

A. The impact of adjusting growth rate of the project from 15 to 13 will decrease the NPV as growth rates directly affects the terminal cash flow decreasing the present value of cash inflows.

The impact of increasing MARR or Hurdle rate of return will also reduce the NPV since the discount rates will decrease again decreasing the present value of cash inflows ultimately decreasing the NPV of the project.

B. Reducing growth rate :

1) A new competitor has launched a product at lesser price or with more attractive features making own product not remaning the best in the market.

2) Increase in production cost due to increase in certain raw material or service prices increasing the price of the product making it less attractive.

3) Regulatory hurdles on importing a particular good or exporting the product directly affecting the tied up revenues of the product.

Increasing discounting rate :

1) MARR increases with risk, there might be business risk involved with the current business practises pushing the basic acceptable return higher.

2) Investors are feeling risky since the liquidity position of org is not healthy pushing the minimum return they command from the company.

3) In view of acquiring new company to affect the valuation of own company MARR is tweaked in order to get a good/bad bid.