Required: (ii) Using the most likely cost of capital of 10%, calculate the sensitivity of Project Attica to changes in: Sales income Initial investment Incremental costs (iii) Write a report highlighting the strengths and weaknesses of the two risk analysis techniques used above and evaluate other ways in which Manor Holdings could take account of risk in investment appraisal.
Manor Holdings plc, a large company with diverse business activities, is currently considering whether it should commence Project Attica and has gathered the following data.
Project Attica Data
(a) An initial investment of £600,000 will be required at the outset. The project has a three year life with a nil residual value.
(b) The most likely sales income the project is expected to generate is:
Year 1 £800,000
2 £900,000
3 £1,000,000
Research suggest these values may be 5% higher in the best case scenario and 5% lower in the worst case scenario.
(c) The incremental costs (including
Year 1 £500,000
2 £600,000
3 £700,000
These costs, net of depreciation, may vary by + or – 10% in the worst and best case scenarios respectively
(d) Estimates of the cost of capital range from 8% (best case) to 12% (worst case) with the most likely bein 10%.The company assesses investments such as Project Attica by calculating the best case NPV and the worst case NPV as well as the most likely NPV. Ignore
Required:
(i) Calculate the best case, most likely case and worse case
reduce the project NPV to zero.
Required:
(ii) Using the most likely cost of capital of 10%, calculate the sensitivity of Project Attica to changes in:
Sales income
Initial investment
Incremental costs
(iii) Write a report highlighting the strengths and weaknesses of the two risk analysis techniques used above and evaluate other ways in which Manor Holdings could take account of risk in investment appraisal.
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