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Scenario & Sensitivity Analysis

Question 1

Greene plc. has the opportunity to invest in plant for the manufacture of a new product, the
demand for which is estimated to be 5,000 units a year for five years. The following data relate
to the decision:

1. The machine is estimated to cost RM50,000 ( payable immediately ) and to have no


residual value.
2. The selling price per unit is planned to be RM10
3. Labor and material costs are estimated to be RM4 and RM3 per unit respectively.
4. Overhead costs are not expected to be affected by the decision
5. The firms cost of finance for such a project is estimated to be 10%
6. The project is not expected to require any additional working capital.
7. In the interests of simplicity taxation will be ignored.

Given below are the estimate changes pertaining to some of variables under two possible
scenario:

SCENARIO
DEPRESSION BOOM
Sales volume Expected value - 10% Expected value + 20%
Unit price Expected value - 5% Expected value + 10%
Labor cost Expected value + 10% Expected value - 5%

Required:
a. What is the Net Present Value of the project?
b. A sensitivity analysis of the above estimates.
c. Calculate the best-case and worst-case NPV figures.

Question 2

Envair Corp. is considering a project which requires an investment of RM12 million in machinery.
This machinery will be depreciated using straight-line over five years period and the salvage value
is estimated to be zero by the end of this machine useful life. The project sales forecast for the
next five years is as follows:

Year 1 2 3 4 5
Sales (units) 70,000 80,000 100,000 90,000 60,000

The selling price per unit is RM160 and the variable cost per unit is RM100. Total fixed costs for
this project (relevant) are RM500,000 per year. The project requires an increase in net working
capital of RM350,000 in the initial year and will be fully recovered at the end of the projects life.
The firms required return on investment of 20%.

However, the company recognizes that some of these estimates are subjected to economic
condition. Given below is the estimated figure under different situation:
Sales volume Selling price Variable costs
Boom + 10% + 5% - 8%
Depression - 10% - 5% +8%

Required:
a. Determine the net present values of this project under best case, base case and worst
case scenario. (17 Marks)
b. Recommend whether the company should invest in this project based on your result in
part (a) (3 Marks)

(Total: 20 Marks)
Question 3

Walton company is evaluating a new project that requires an acquisition of a new equipment
costing RM600,000. The expected disposable value of this equipment would be RM40,000 at the
end of projects life. The forecasted sales volume is 40,000 units per annum and the selling price
is RM25 per unit. The labor costs per unit and material costs per unit are expected to be RM12
and RM6 respectively. Fixed cost (relevant) is RM70,000 per annum. The projected project is 5
years. The required return on this project is 20%.

Required:
a. Calculate the net present value for this project. (6 Marks)
b. Given below is the estimated figure under different economic situation, calculate the best and
worst case NPV of this project.

Sales volume Selling price Material costs


Boom + 15% +6% - 7%
Recession -12% -6% +5%
(14 Marks)

(Total: 20 Marks)

Question 4

Olympia Bhd. has an investment opportunity with the following characteristics:


Cost of investment RM600,000 with zero salvage value at the end of projects life.
Expected sales volume: 30,000 units per annum for 4 years
Unit selling price: RM30
Unit labor cost: RM13
Unit material cost: RM7
Fixed costs (relevant): RM60,000 per annum for 4 years
Projects life: 4 years
Cost of capital: 16%

Required:
a. Perform a sensitivity analysis on the following variables:
i. Selling price
ii. Labor cost
iii. Material cost
iv. Fixed costs
v. Sales volume (16 marks)

b. Based on the information derived from (a) above, advise Olympia whether to invest or not
to invest in this project. (4 marks)

(Total: 20 Marks)

Question 5

Harvest Bhd. is considering a project which requires an investment of RM1.8 million in machinery
with zero salvage value after 4 years. This machinery will be depreciated using straight-line over
this period. The project sales forecast for the next 4 years is 46,000 units per annum. The selling
price per unit is RM38, the labor costs per unit are RM13 and the raw material costs are RM8.
The project does not require any additional working capital and fixed cost. The firms required
return on investment of 14%.

Required:

a. Calculate the Net Present Value of this project. (5 marks)

b. Perform a sensitivity analysis on the selling price, labor costs, material costs, and sales
volume. Based on the analysis, recommend whether the company should invest in this
project. (10 marks)

c. Explain briefly two approaches of what-if analysis technique. (5 marks)

(Total: 20 Marks)