Old Machine Parameters

Old Machine Cost

Revenue first 5 yrs
Revenue After 5 yrs
Old Machine Salvage
Value
Net Book Value of Old
Machine
Tax Credit
Cash Flow from Old
Machine
Old Machine Operating
Expense

1,000,000.00
700,000.00
400,000.00
350,000.00

400,000.00
22,500.00
372,500.00
300,000.00

New Machine Parameters

New Machine Cost

New Machine Delivery
Cost
New Machine
Installation Cost
New Machine
Opertating Expense
Tax Rate
Hurdle Rate

1,200,000.00
20,000.00
30,000.00
150,000.00
0.45
0.20

Old Machine
Year

Investment

1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00
11.00
12.00
Old Machine

New Machine

1,000,000.00

Year

Year

1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00
11.00
12.00

Investment

1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00

1,200,000.00

Incremental Analysis
Year

NCF New Machine

- 1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00
9.00
10.00

877,500.00
482,500.00
446,500.00
410,500.00
374,500.00
338,500.00
137,500.00
137,500.00
137,500.00
137,500.00
137,500.00

New investment fails to meet investments criterion since NPV

negative at 20%

(Gotten from 2 years total sum of the years drepreciation)

(Salvage Value - Net Book Value) x Tax
(Salvage Value + Tax Credit)

Sales

700,000.00
700,000.00
700,000.00
700,000.00
700,000.00
400,000.00
400,000.00
400,000.00
400,000.00
400,000.00
400,000.00
400,000.00

Opertating Expenses

300,000.00
300,000.00
300,000.00
300,000.00
300,000.00
300,000.00
300,000.00
300,000.00
300,000.00
300,000.00
300,000.00
300,000.00

Delivery & Installation Cost

Sales

50,000.00

350,000.00
700,000.00
700,000.00
700,000.00
700,000.00
700,000.00
400,000.00
400,000.00
400,000.00
400,000.00
400,000.00

NCF Old Machine

s criterion since NPV

New - Old

310,000.00
280,000.00
250,000.00
55,000.00
55,000.00
55,000.00
55,000.00
55,000.00
55,000.00
55,000.00

Operating Expenses

150,000.00
150,000.00
150,000.00
150,000.00
150,000.00
150,000.00
150,000.00
150,000.00
150,000.00
150,000.00

Hurdle Rate @ 20%

877,500.00
172,500.00
166,500.00
160,500.00
319,500.00
283,500.00
82,500.00
82,500.00
82,500.00
82,500.00
82,500.00

1.00
0.83
0.69
0.58
0.48
0.40
0.33
0.28
0.23
0.19
0.16

NPV @ 20%

(IRR - 10) / (20 - 10) = (0 - 125,948.38)

(IRR - 10) / 10 = -125,948.38 / -284,025
IRR - 10 = 10 * 0.443
IRR = 10 + 4.43 = 14.43%

My recommendation would change if t

Profit Before Tax

1,000,000.00
400,000.00
400,000.00
400,000.00
400,000.00
400,000.00
100,000.00
100,000.00
100,000.00
100,000.00
100,000.00
100,000.00
100,000.00

Depreciation

333,333.33
266,666.67
200,000.00
133,333.33
66,666.67
-

Taxable Income

66,666.67
133,333.33
200,000.00
266,666.67
333,333.33
100,000.00
100,000.00
100,000.00
100,000.00
100,000.00
100,000.00
100,000.00

Profit Before Tax

900,000.00
550,000.00
550,000.00
550,000.00
550,000.00
550,000.00
250,000.00
250,000.00
250,000.00
250,000.00
250,000.00

PV @ 20%

877,500.00 143,750.00
115,625.00
92,881.94
154,079.86
113,932.29
27,629.08
23,024.24
19,186.86
15,989.05
13,324.21

158,077.46

Depreciation

- 400,000.00
320,000.00
240,000.00
160,000.00
80,000.00
-

PV @ 10%

877,500.00
156,818.18
137,603.31
120,586.03
218,222.80
176,031.20
46,569.10
42,335.54
38,486.86
34,988.05
31,807.32

125,948.38

20 - 10) = (0 - 125,948.38) / (-158,077.46 - 125,948.38)

0 = -125,948.38 / -284,025.84

.43 = 14.43%

ndation would change if the hurdle rate is >= 14.43%

Taxable Income

900,000.00
150,000.00
230,000.00
310,000.00
390,000.00
470,000.00
250,000.00
250,000.00
250,000.00
250,000.00
250,000.00

Tax @ 45%

- 30,000.00
60,000.00
90,000.00
120,000.00
150,000.00
45,000.00
45,000.00
45,000.00
45,000.00
45,000.00
45,000.00
45,000.00

Profit After Tax

1,000,000.00
370,000.00
340,000.00
310,000.00
280,000.00
250,000.00
55,000.00
55,000.00
55,000.00
55,000.00
55,000.00
55,000.00
55,000.00

Tax @ 45%

22,500.00 67,500.00
103,500.00
139,500.00
175,500.00
211,500.00
112,500.00
112,500.00
112,500.00
112,500.00
112,500.00

Profit After Tax

877,500.00
482,500.00
446,500.00
410,500.00
374,500.00
338,500.00
137,500.00
137,500.00
137,500.00
137,500.00
137,500.00
1,862,500.00

125,948.38
284,025.84

0.44

4.43
14.43

OUTCOME

PAYOFF
80.00
80
40,000.00
90
36,000.00
100
32,000.00

90.00
40,000.00
45,000.00
41,000.00

80.00

0.50

90.00

0.20

EMV

###

0.30

DECISION = To maximize EMV or profit, Raphael s

(ii)

Without info
With info

80.00

0.50

90.00

0.20

100.00

0.30

DECISION = Do not accept company's offer becau

(iii)

At r discount
80.00

0.50

90.00

0.20

100.00

0.30

0.5(40-7.2r) + 0.2(45-81r) + 0.3 (50

20-36r+9-16.2r+15-27r
44 - 79.2r
79.2 r
r

DECISION: The maximum discount the information is worth is 4

INCIDENCE
100.00
40,000.00
45,000.00
50,000.00

25
10
15
50

0.5
0.2
0.3

80.00
90.00
100.00

20,000.00
8,000.00
12,000.00

40,000.00

80.00
90.00
100.00

18,000.00
9,000.00
13,500.00

40,500.00

80.00
90.00
100.00

16,000.00
8,200.00
15,000.00

39,200.00

aximize EMV or profit, Raphael should produce 90 cakes

40,500
36,400.00

18200

40,950.00

8190

45,500.00

13650

40,040.00

ot accept company's offer because it gives a lower EMV

80(900-900r - 400)

80(500-900r) 80(0.5-0.9r)

40-7.2r

90 (900-900r-400)

90(0.5-0.9r) 45-81r

100(900 - 900r-400)

100(0.5-0.9r) 50-90r

40-7.2r) + 0.2(45-81r) + 0.3 (50-90r)

40.5

36r+9-16.2r+15-27r
-

40.5
40.5
3.50
0.044

unt the information is worth is 4.4%

A
80
20
20
4

Investment
Working capital
Straight line depreciation
Life

NORMAL
Probability
Sales revenue
Total costs
EV of sales

0.7
100
50
70

V.COMPETITIVE
Probability
Sales revenue
Total costs
EV of sales

0.3
80
50
24
A

year
0
1
2
3
4

Investment

-80

B
Year
0
1
2
3
4

Investment

-120

Alternative A (22.7)

Alternative B (15.67)

Select Alternative A

(d)

34.1p - 3.9(1-p) = 15.67

34.1p - 3.9 + 3.9p = 15.67
38p = 19.57
p = 51.5%

B
120
40
30
4

0.7
100
30
70

0.3
60
30
18
NORMAL
Working capital

Revenue

Expense

PBT & Depr

-20
100
100
100
100

20

-50
-50
-50
-50

-100
50
50
50
70

Deprciation

-20
-20
-20
-20

NORMAL
Working capital

Revenue

Expense

PBT & Depr

-40
100
100
100
100

-30
-30
-30
-30

Normal (0.7)
Very competitive (0.3)

34.1
-3.9

23.87
-1.17

Normal (0.7)
Very competitive (0.3)

38.5
-37.6

26.95
-11.28

40

-160
70
70
70
110

Deprciation

-30
-30
-30
-30

p) = 15.67
3.9p = 15.67

10.00%
Taxable
income

Tax

0
30
30
30
30

Taxable
income

NCF

0
12
12
12
12

Tax

0
40
40
40
40

PV @ 10%

-100
38
38
38
58

-100.0
34.5
31.4
28.5
39.6

72

34.1

NCF

0
16
16
16
16

PV @ 10%

-160
54
54
54
94

-160.0
49.1
44.6
40.6
64.2

96

38.5

year
0
1
2
3
4

Year
0
1
2
3
4

VERY COMPETITIVE

Investment

Working capital

-80

Revenue

-20
80
80
80
80

20

VERY COMPETITIVE

Investment

Working capital

-120

Expense

Revenue

-50
-50
-50
-50

Expense

-40

40

60
60
60
60

-30
-30
-30
-30

PBT & DeprDeprciation

-100
30
30
30
50

-20
-20
-20
-20

PBT & DeprDeprciation

-160
30
30
30
70

-30
-30
-30
-30

Taxable
income

Tax

0
10
10
10
10

Taxable
income

NCF

0
4
4
4
4

Tax

0
0
0
0
0

PV @ 10%

-100
26
26
26
46

-100.0
23.6
21.5
19.5
31.4

24

-3.9

NCF

0
0
0
0
0

PV @ 10%

-160
30
30
30
70

-160.0
27.3
24.8
22.5
47.8

-37.6

(a)

MODEL A

PAYOFF
1
1.5
1.4
EMV

MODEL B

0.8
1.8
1.2
EMV

MODEL C

0.6
1.6
2.1
EMV

Decision = Accept Model C because it has the highest EMV

(ii)

EVPI

Without Information
With information

Decision = Seek perfect information but don't pay more than 0.

(iii)

Favorable
ALTERNATIVE PROBABILITY
s1
s2
s3

0.4
0.2
0.4

Unfavorable
ALTERNATIVE PROBABILITY
s1
s2
s3

0.4
0.2
0.4

EVPI

Without information
With information
1.49694

EVPI = 1.4964 - 1.4 = 964. Hence the survey is ov

(b)

d1
s1
s2
s3

0.1
0.3
0.6

d2
s1
s2
s3

0.1
0.3
0.6

d3
s1
s2
s3

0.1
0.3
0.6

d4
s1
s2
s3

0.1
0.3
0.6

Optimal decision is option d3

D1
PAYOFF

PREFERENCE VALUE
100
50
40
20
-10
-30
-60

Risk Averter
Optiml decision is d3
RP = EMV - CE
2
>0
Risk averter

1
0.94
0.9
0.8
0.6
0.4
0

PROBABILITY

EV
0.4
0.2
0.4

0.4
0.3
0.56
1.26

0.4
0.2
0.4

0.32
0.36
0.48
1.16

0.4
0.2
0.4

0.24
0.32
0.84
1.4

because it has the highest EMV

1
1.8
2.1

1.4
0.4
0.36
0.84
1.60

0.4
0.2
0.4

ormation but don't pay more than 0.2

CONDITIONAL P. JOINT P.
ADJUSTED P.
0.2
0.08 0.14814815
0.5
0.1 0.18518519
0.9
0.36 0.66666667
0.54

CONDITIONAL P. JOINT P.
ADJUSTED P.
0.8
0.32 0.69565217
0.5
0.1 0.2173913
0.1
0.04 0.08695652
0.46
1.4
Favorable

A
0.54

s1
s2

0.15
0.19

1
1.5

1.801
0.97254

Unfavorable

s3

0.67

1.4

s1
s2
s3

0.15
0.19
0.67

0.8
1.8
1.2

s1
s2
s3

0.15
0.19
0.67

0.6
1.6
2.1

S1
S2
S3

0.7
0.2
0.1

1
1.5
1.4

S1
S2
S3

0.7
0.2
0.1

0.8
1.8
1.2

S1
S2
S3

0.7
0.2
0.1

0.6
1.6
2.1

0.46
1.14
0.5244

4 - 1.4 = 964. Hence the survey is overpriced at 100.

EMV

D1

100
40
-60

10
12
-36

50
20
-30

5
6
-18

20
20
-10

2
6
-6

40
20
-60

4
6
-36

-14

1
0.9
0

0.1
0.27
0

-7

0.94
0.8
0.4

0.094
0.24
0.24

0.8
0.8
0.6

0.08
0.24
0.36

-26

0.9
0.8
0

0.09
0.24
0

D2
PAYOFF

PREFERENCE VALUE
100
1
50
0.58
40
0.5
20
0.35
-10
0.18
-30
0.1
-60
0

Risk taker
Optimal decision is d1
RP = EMV - CE
-49
<0
Risk taker

0.15
0.285

0.938

1.373

0.12
0.342
0.804

1.266

0.09
0.304
1.407

1.801

0.7
0.3
0.14

1.14

0.56
0.36
0.12

1.04

0.42
0.32
0.21

0.95

D1

D2

0.37

1
0.5
0

0.1
0.15
0

0.25

0.574

0.58
0.35
0.1

0.058
0.105
0.06

0.223

0.68

0.35
0.35
0.18

0.035
0.105
0.108

0.248

0.33

0.5
0.35
0

0.05
0.105
0

0.155

Assemblies
Decision: Buy or Make
BUY
MAKE

Cost
Internal Loss
Fractions of parts not meeting specifications

Fixed cost
Variable cost
Cost of replacement

BUY DECISION
MAKE DECISION
1
2
3
4
5
6

MAKE DECISION
Variable cost
Cost of replacement
Fixed Cost

DECISION = Make because it is cheaper

(ii)

EMV Without information

With information

DECISION: Seek perfect information because the cost is cheape

5000

15.8
50%

79,000.00

0
5%

10%
40%

20%
25%

30%
15%

40%
10%

20,000
10
8

79,000.00

UNITS
LOSS
Loss %
5,000.00
5,000.00
500.00
5,000.00
1,000.00
5,000.00
1,500.00
5,000.00
2,000.00
5,000.00
2,500.00

0.1
50,000.00
8,000.00
20,000
78,000.00

4,000.00

PROBABILITY PROBABLE LOSS

0
0.05
0.1
0.4
200.00
0.2
0.25
250.00
0.3
0.15
225.00
0.4
0.1
200.00
0.5
0.05
125.00
1
1,000.00
0.2

0.3

8,000.00

78,000
5% (No Loss) Make
Buy

70,000 x
79,000

3500

40% (10% LosMake

Buy

74,000 x
79,000

29600

25% (20% LosMake

Buy

78,000 x
79,000

19500

15% (30% LosMake

Buy

82,000
79,000 x

10% (40% LosMake

Buy

86,000
79,000 x

5% (50% LossMake
Buy

90,000
79,000 x

ecause the cost is cheaper

11850

7900

3950
76300

50%
5%

(A)

Rent umbrella (11,000)

Don't rent umbrella (12,000)

DECISION: Don't rent umbrella

(aii)

Without info
With info (12,750)

DECISION: Seek info but don't pay more than 750

(b)

PROBABILITY
1
0.75
0.5
0.25
0

Re-evaluaton:
Rent umbrella (0.4)

Don't rent umbrella (0.7)

DECISION: She should still not rent

Certainty equivalent = N13,500
Risk Premium Rent = EMV - CE = 11,000 - 13,500 = (2,500)

Risk Premium Do Not Rent = EMV - CE = 12,000 - 13,500 = (

She is a risk seeker because the risk premium is less than 0

Rain (0.3)
No rain (0.7)

7,500.00
12,500.00

Rain (0.3)
No rain (0.7)

5,000.00
15,000.00

12,000
Info says rain (7,500)

With umbrella (7,500)

Without umbrella (5,000)

Info says no rain (15,000)

With umbrella (12,500)

Without umbrella (15,000)

t don't pay more than 750

CE
15,000
14,000
12,500
10,000
5,000

Rain (0.3)
No rain (0.7)

0.15
0.50

0.05
0.35

Rain (0.3)
Don't rain (0.7)

1.00

0.70

till not rent

MV - CE = 11,000 - 13,500 = (2,500)

ent = EMV - CE = 12,000 - 13,500 = (1,500)

ause the risk premium is less than 0

0.40

0.70

(i)

EMV Without test

POSSIBLE OUTCOME
Gas
No gas

POTENTIAL TEST RESULT

GAS
0.7
0.1

TEST SAYS GAS

OUTCOME
Gas
No Gas

ORIGINAL P.
0.6
0.4

TEST SAYS NO GAS

OUTCOME
Gas
No Gas

ORIGINAL P.
0.6
0.4

EMV With test

(ii)

Maximum amount to pay for the test = 1.18 - 1 = 0.18

(iii)

EMV Without info

EMV With info

EMV = 2.1 - 1

Test says gas

2.1
Test says no
0

1,100,000.00

Gas

0.6

1.8

No Gas

0.4

-2

-0.8
1

ENTIAL TEST RESULT

NO GAS
0.3
0.9

CONDITIONAL P. JOINT P.
REVISED P.
0.7
0.42 0.91304348
0.1
0.04 0.08695652
0.46

CONDITIONAL P. JOINT P.
REVISED P.
0.3
0.18 0.33333333
0.9
0.36 0.66666667
0.54

Test says Gas

Gas
No Gas

0.91304348
0.08695652

3 2.73913043
-2 -0.17391304
2.56521739

Test says No Gas

Gas
No Gas

0.33333333
0.66666667

3
1
-2 -1.33333333
-0.33333333

EMV

1.18
0

1.18

0.7 Exploit
Don't exploit
0.9 Exploit
Don't exploit

3
0
-2
0

or the test = 1.18 - 1 = 0.18

Without Information
Don't bid
Bid

Good weather
Bad weather

EMV Without info = 200,000

With Imperfect Information

OUTCOME
Good weather
Bad weather

POTENTIAL FORECAST
Good weather
0.7
0.2

FORECAST SAYS GOOD WEATHER

OUTCOME

ORIGINAL PROBABILITY

Good weather
Bad weather

0.2
0.8

FORECAST SAYS BAD WEATHERORIGINAL

Good weather
Bad weather

Forecast

0.2
0.8

Forecast says Good weat

Forecast says Bad weath

EMV with forecast/info = 546,000

Cost of imperfect info = 546,000 - 200,000 = 346,000

DECISION: Company should not employ the forecasting company because th

Maximum loss

154,000.00

With perfect information

Forecast

Good weather

Bad weather

Without forecast

Maximum worth of perfect info = 3.5 - 0.2 = 3.3m

0
0.2

0.8

-1

-0.8

0.2

Bad weather
0.3
0.8

CONDITIONALJOINT
0.7
0.2

ADJUSTED
0.14 0.46666667
0.16 0.53333333
0.3

CONDITIONALJOINT
0.3
0.8

ADJUSTED
0.06 0.08571429
0.64 0.91428571
0.7

0.3 BID
1.82
0.546
DON'T BID

Good weather
Bad weather

0.47
0.53

5
-1

2.35
-0.53
1.82
0

0.7 BID
0
0
DON'T BID

Good weather
Bad weather

0.09
0.91

5
-1

0.45
-0.91
-0.46
0

recasting company because the cost (500,00) is greater than the value (346,000)

0.7 BID
5 DON'T BID
3.5

5X
0

0.8 BID
0 DON'T BID
0

-1
0X

0.2

Is business worth keeping?

Net Income
Expansion option
Upping sales on Monday - Wednesday
Meet forecasts?

Is offer worth business?

Loans
Accounts Payable
Petty's contract

Can she pay interest?

Can she pay principal?
Can she pay study loan?

Yes
Yes
Yes