A company operates under hard budget constraints and has a WACC of 12%. In the current year it can spend a maximum of Kshs. 80 million on a new investment. The management is considering two alternative projects: Project 1 and Project 2, each of the two projects would run for two years and be sold at a fair price. Both of the projects require Kshs. 80 million initial investments and have present values without flexibility equal to Kshs. 100 million. However project 1 has an annual volatility of 40% and project 2 has an annual volatility of 20%. Both projects allow the management to contract operations by 40% and at any time during the next two years. With project 1 the cash received from contracting would be Kshs. 33 million and with project 2 it would be Kshs. 42 million. The risk free rate is 5%. Using a decision tree analysis (DTA) answer the following questions: Which project should the company selects, and what other factors should be considered while making the decision?
A company operates under hard budget constraints and has a WACC of 12%. In the current year it can spend a maximum of Kshs. 80 million on a new investment. The management is considering two alternative projects: Project 1 and Project 2, each of the two projects would run for two years and be sold at a fair price. Both of the projects require Kshs. 80 million initial investments and have present values without flexibility equal to Kshs. 100 million. However project 1 has an annual volatility of 40% and project 2 has an annual volatility of 20%. Both projects allow the management to contract operations by 40% and at any time during the next two years. With project 1 the cash received from contracting would be Kshs. 33 million and with project 2 it would be Kshs. 42 million. The risk free rate is 5%. Using a decision tree analysis (DTA) answer the following questions:
Which project should the company selects, and what other factors should be considered while making the decision?
Step by step
Solved in 2 steps with 1 images
