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Techniques for Risk Analysis
Scenario Analysis
Q.1 From the under mentioned facts, compute NPVs of the two projects for each of the possible cash flows, using sensitivity analysis.
Particular Project X Project Y
Initial cash outlay (t = 0) Rs.40,000 Rs.40,000
Cash flow estimate (t = 1-15) z
Worst Rs.6,000 0
Most-likely Rs.8,000 8,000
Best Rs.10,000 16,000
Required rate of return 0.10 0.10
Economic life (years) 15 15
10% PVAF 7.606
Q.2
The following information is available regarding the expected
cash flows generated, and their probability for company X. What is expected return on the project? Assuming 10% as cost of capital find out the present values of expected monetary values. Cash outflow of the project is Rs. 20,000
Q.4 Assume that a project has a mean of Rs.40 and Standard
Deviation of Rs.20. The management wants to determine the probability of the NPV under the following ranges: (i) Zero or less; (ii) Greater than Zero; (iii) between the range of Rs.25 and Rs.45; (iv) between the range of Rs.15 and Rs.30
Q.5The Delta corporation is considering an
investment in one of the two mutually exclusive proposals: Project A which involves an initial outlay of Rs.1,70,000 and Project B which has an outlay of Rs.1,50,000. The certainty-Equivalent approach is employed in evaluating risky investments. The current yield on treasury bills is 0.05 and the company uses this as a riskless rate. The expected values of the cash flows with their respective CE coefficients are:
Year Project A Project B
Cash Certaint Cash Certaint Flows y Flows y (Rs. Equivale (Rs. Equivale ‘000) nt ‘000) nt 1 90 0.8 90 0.9 2 100 0.7 90 0.8 3 110 0.5 100 0.6
(i) Which project should be acceptable to the company?
(ii) Which project is riskier? How do you know? (iii) If the company was to use the RADR method, which project would be analyzed with the higher rate?
ANS: i-NPV of A = 9,554 and NPV of B = Rs.44,256
Q.6 Suppose a firm has an investment proposal,
requiring an outlay of Rs.2,00,000 at present (t = 0). The investment proposal is expected to have 2 years’ economic life with no salvage value. In year 1 there is 0.3 probability that CFAT will be Rs.80,000; a 0.4 probability that CFAT will be Rs.1,10,000 and a 0.3 probability that CFAT will be Rs.1,50,000. In year 2, the CFAT possibilities depend on the CFAT that occurs in the year 1. That is, the CFAT for the year 2 are conditional on CFAT for the year 1. Accordingly, the probabilities assigned with the CFAT of the year 2 are conditional probabilities. The estimated conditional CFAT and their associated conditional probabilities are as follows:
1,50,000 Q. A company is considering an investment in a project that requires an initial net investment of Rs.3,000 with an expected cash flow (CFAT) generated over three years as follows:
y y y Rs.800 0.1 Rs.800 0.1 Rs.800 0.2 1,000 0.2 1,000 0.3 1,000 0.5 1,500 0.4 1,500 0.4 1,500 0.2 2,000 0.3 2,000 0.2 2,000 0.1
(a) What is expected NPV of this project? (Assume the
probability distributions are independent and the risk free rate of interest in the market is 0.05).
(b) Calculate the standard deviation about the
expected value.
(c) Find the probability that the NPV will be less than Zero. (Assume the distribution is normal and continuous) (d) What is the probability that the NPV will be greater than Zero.
(e) What is the probability that the NPV will be (i)
between the range of Rs.500 and Rs.750, (ii) between the range of Rs.400 and Rs.600, (iii) at least Rs.300 and (iv) at least Rs.1,000. EANV approach of selecting project
A firm is considering to buy one of the following two mutually
exclusive investment projects:
PROJECT A: Buy a machine that requires an initial outlay of
Rs.1,00,000 and will generate CFAT of Rs.30,000 per year for 5 years.
PROJECT B: Buy a machine that requires an initial outlay of
Rs.1,25,000 and will generate CFAT of Rs.27,000 per year for 8 years.
Which project should be undertaken by the firm? Assume
10% cost of capital.
Q. BREAK EVEN ANALYSIS
A firm has the following income statement. For a
month.
Sales: 3,000 units at Rs.80/unit Rs.240,000
Less: Cost of Goods Sold: Variable Production Cost 180,000 Fixed Production Cost 19,800
Gross Margin 40,200
Selling and Administrative Expenses Variable Selling Cost 21,000 Fixed Selling Expenses 7,500 Net Income Before Taxes 11,700
1. Find the firm’s breakeven output.
2. If it wishes to have a monthly net income before taxes of
Rs.18,000 and its cost structure remains as above, what quantity of output will it need to sell?
3. If its variable production costs increase by Rs.4 per unit, what
will be its breakeven output?
4. After the increase in costs in 3, what output will it need to sell if
it wishes to have the Rs.18,000 monthly pretax profit stated earlier? 5. Given the variable production cost increase but no change in fixed costs, what will be the firm’s monthly profit if it sells 4,000 units of output per month?
