Investment Project (A)

The company ABC sells t-shirts and shirts, but is considering getting involved in the
production of pants. The entry costs for the production of pants (which include the purchase
of new machinery, capacitation of workers, etc.) are US$ 100,000. The economic life of the
machinery is five years, and the depreciation of the machinery will be $ 15,000 per year
during its productive life of five years. The rescue value of the machinery at the end of the
five years will be zero.
The manager of new product development is certain that the company will sell
6,000 pants in the first year. However, the demand of the following years (year 2, year 3,
year 4 and year 5) is uncertain. He has information about the growth rate of sales of four
companies (A, B, C y D) in the market of pants (Table 1). These companies sell pants in the
same market segment as would ABC. The company ABC could use statistics of the rates of
growth of those companies as proxies of the mean and standard deviation of its own growth
rate of sales for years 2-5.1
The manager estimates that each pant will be sold by US$26 per unit in the five
years. Fixed costs are US$ 12,500 per year, whereas the variable cost will be around 73%
of total sales each year. The company will fund the project with its own resources. The cost
of capital of the company is 8% and the tax rate is 30%.
The manager is interested in estimating the net present value of the project (NPV)
and the internal rate of return. He recognizes, however, that it will be impossible to provide
an exact value for NPV or the rate of return due to the uncertainty of the growth rate of
sales. A useful probability distribution that reflects the performance of the growth rate of
sales is the normal distribution. One advantage of this distribution is that it allows very high
and very low values, and the probability of extreme values is low.
The manager needs to have some information about the net present value and
internal rate of return of the project. He is told that a Montecarlo simulation will be
extremely useful to estimate statistics and probabilities about the NPV and the return of the
project. The company needs to know not only the expected value and standard deviation of
the financial indicators, but also the risk.

1
The commands PROMEDIO and DESVEST can be used to calculate the mean and standard
deviation of the rates of growth.
Table 1
Firms
A B C D
2007 5.60% 3.20% 5.60% 1.80%
2008 1.30% 0% -1.20% 0.50%
2009 0% 0.10% -1.50% 0.60%
2010 1.10% 0.40% -0.10% 0.60%
2011 4.10% 3.40% 4.30% 2.10%
2012 1.7% 4.1% 4.1% 1.3%
2013 1.9% 1.1% 0.1% 0.1%
2014 2.28% 1.9% 2.1% 1.1%
2015 3.1% 2.1% -0.1% 1.2%
2016 2.30% 2.10% 1.90% 4.70%