*maximize NPV a. Given Classy’s current 8 year lifecycle for their cars, calculate: The NPV for each Regal The IRR for each Regal The Payback Period for each Regal b. If each car represents a nonrepeatable or onetime project, what would the optimal time to abandon each Regal? In other words, what is the economic life of the Regal? What is the NPV for this economic life? c. If each car represents a repeatable project (for as many cycles as you want), what would the optimal time to abandon each Regal? What would the NPV be if the project were repeated 4 times? One year project: Yr. 0: 35.7Yr.1 : 15.4 + NSV of 27.4 R = 10% NPV = [(15.4 + 27.4) / 1.10] – 35.7 = 3.21 Two year project: Yr. 0 = 35.7 Yr. 1 = 15.4 Yr. 2 = 12.3 + NSV of 25 Use CF to solve: CF0 = 35.7 C01 = 15.4 C02 = 12.3 +25 = 37.3 I = 10 NPV = 9.13 Three year project: CF0 = 35.7 C01 = 15.4 C02 = 12.3 C03 = 10.3 + 21 = 31.3 I = 10 NPV = 11.98 Four year project: CF0 = 35.7 C01 = 15.4 C03 = 10.3 C04 = 8.6 + 14 = 22.6 I = 10 NPV = 11.64 here, 3 years gives the highest NPV Why? PV of quitting > PV of continuing End of year 3: Quit = NSV = 21 Continue one more year = 8.6 + 14 = 22.6 Compare at year 3 = 22.6/1.10 = 20.55 < 21 PROJECT RISK: 3/28So far, we have assumed that the cash flows for our projects are known with certainty. This is seldom the case in practice, so we need to account for uncertainty in our projects. There are a few ways to measure this uncertainty in cash flows. there’s uncertainty in forecasting project cash flows 3 ways to measure project uncertainty: 1. Sensitivity analysis a. Change value of one variable at a time i. Sales, growth, pricing, inventory b. Observe the impact on NPV c. See the range where NPV is still positive 2. Scenario Analysis a. Consider two or three project outcomes or cases i. Cases: bad, average, good 1. Calculate the NPV for each case 2. Range for NPV 3. Assign probabilities for each case and calculate the expected NPV 3. Monte Carlo Simulation a. Assign a distribution of possible values for each variable i. Sales yr. 1: normally distributed ii. COGS yr. 1: normally distributed b. At random, we pick a value from each distribution c. Calculate NPV d. 5001,000 trials e. Take trials and calculate the following: i. Average or expected NPV ii. Standard deviation for NPV iii. Probability of NPV > 0 EXAMPLE: Suppose that the Green Bay Packers are trying to weight an investment decision in a new stadium expansion. The analyst wants to consider two scenarios, GOOD and BAD, to evaluate the opportunity. In the GOOD case, the team continues to perform well and all new seats are sold every season. In the BAD case, the team does not play well on the field and fan support declines. The probability of the GOOD case is estimated to be 80%, while the probability of the BAD case is estimated at 20%. Management will value this opportunity in perpetuity. The Packers have a discount rate of 6%, and cash flows are expected to grow at 3% per year going forward. The cash flows are shown below:
A. What is the NPV of the BAD case? B. What is the NPV of the GOOD case? C. What is the expected NPV of the project? D. Suppose that management is not sure of the probability of success for the team. What probability of the GOOD case allows the project to break even?
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