Question

Grow Corp is a medium sized Commodity Producer. It is already involved with industries such as oil and gas, forest products and gold exploration. Grow Corp operates in Australasia as well as North America and the company exports everywhere in the world. The General Manager of Grow Corp, Mr Tandori Nanczos, is very much in favour of expanding operations into new markets and is considering developing a new plant that will specialise in the production of Cannabis for medicinal and legitimate business activities. Legitimate Cannabis cultivation for industrial hemp is estimated to yield up to $800 per Acre. Mr Tandori Nanczos is considering the implementation of the following strategy in order to produce hemp for the domestic market. Strategy HEMP involves the traditional method of purchasing a block of land in central Victoria and establishing the site for productive measures. Mario Williams, a Financial Analyst, has prepared estimates of the initial investment, the Net Cash inflows associated with each method given two future possible states of the world. RISK AND RETURN HEMP PRODUCTION BEST CASE HEMP PRODUCTION WORST CASE Initial Investment (t=0) $3,750,000 $3,750,000 Year (t) Cash Inflows Cash Inflows 1 $1,126,000 $975,000 2 $1,351,200 $1,121,250 3 $1,621,440 $1,255,800 4 $1,945,728 $1,368,822 5 $2,237,587 $1,450,951 Probability (Event) 0.60 0.40 Note that Mario plans to analyse each alternative over a five-year period. At the end of that time, the equipment required for each method would be sold, thus accounting for the large final year Cash Inflow. Mario believes that, due to the operation will have no impact on the firm’s overall risk. It is, therefore, decided to use the firms’ 12% Cost of Capital when analysing the proposed project. Mario would like you to estimate the following: (a) Expected Net Present Value (b) Standard Deviation (c) Coefficient of Variation

Answer 1

	PROBABILITY 0.60:
	Year	Cash flow	PV at 12%	PV at 12%
	0	-3750000	1	$     -37,50,000
	1	1126000	0.89286	$       10,05,357
	2	1351200	0.79719	$       10,77,168
	3	1621440	0.71178	$       11,54,109
	4	1945728	0.63552	$       12,36,545
	5	2237587	0.56743	$       12,69,667
	NPV			$       19,92,847
	PROBABILITY 0.40:
	Year	Cash flow	PV at 12%	PV at 12%
	0	-3750000	1	$     -37,50,000
	1	975000	0.89286	$         8,70,536
	2	1121250	0.79719	$         8,93,854
	3	1255800	0.71178	$         8,93,854
	4	1368822	0.63552	$         8,69,911
	5	1450951	0.56743	$         8,23,309
	NPV			$         6,01,463
a)	Expected NPV:
		Probability
		0.6	0.4
	NPV	$                     19,92,847	$                                6,01,463
	Expected NPV = 1992847*0.6+601463*0.4 =			$       14,36,293
b)	Deviation from Mean [d]	$                       5,56,553	$                               -8,34,831
	d^2	$     3,09,75,16,32,158	$              6,96,94,23,38,496
	p*d^2	$     1,85,85,09,79,295	$              2,78,77,69,35,398
	SD = (185850979295+278776935398)^0.5 =		$                                6,81,636
c)	Coefficient of variation = 681636/1436293 =		0.47