Posted: September 16th, 2022

Risk Analysis and Project Evaluation: NPV Scenario Analysis

Risk Analysis and Project Evaluation: NPV Scenario Analysis

Work on two scenarios corresponding to the worst- and best-case outcomes that are defined in terms of the estimated values for each value driver of the project. You need to provide your results in (a) relevant tables:
Risk Analysis and Project Evaluation: NPV Scenario Analysis
Case Study:
Your company needs to take another capital budgeting consideration regarding expansion of seafood product market. Your Financial Team was assigned the job to evaluate the potential risks of a new project. In the new project, the company will launch a new product line that is expected to boost the sales by 10%.
The new project is expected to generate an annual sale of 3,500,000 units for an average price of $3.50 per unit for 5 years.
The new investment project requires your company to buy a new assembly line with initial cost of $1,250,000, a residual value of $250,000 at the end of the project.
The company will need to add $160,000 in working capital which is expected to be fully retrieved at the end of the project. Other information is available below:
Depreciation method: straight line
Variable cost per unit: $1.2
Cash fixed costs per year: $50,000
Corporate marginal tax: 30%
Discount rate: 11%
Your Finance Department conducted some economics forecast and estimated that in the coming time, post-Covid-19 pandemic and Russia- Ukraine war economic conditions may cause uncertainty in canned seafood market demand. You Finance Department decides to do a scenario analysis to determine the sensitivity of the project’s NPV to different scenarios.

Required:
Work on two scenarios corresponding to the worst- and best-case outcomes that are defined in terms of the estimated values for each value driver of the project. You need to provide your results in (a) relevant tables:

Worst case: The Covid-19 pandemic is totally over. People despise canned foods as it reminds them of eating home alone under lockdowns and restriction. Your company’s new canned seafood product is therefore subject to a decrease in market demand. More expensive energy due to Russia- Ukraine war adds another pressure on production. The unfavourable economic condition causes: Unit sales decrease by 10%; price per unit decreases by 10%; variable cost per unit increases by 10 %; cash fixed cost per year increases by 10%
Best case: The pandemic is gone. However, people are still concerned about its coming back and the natural disasters such as floods in Queensland and New South Wales in early 2022. They developed the habit to buy canned foods as a compulsory part of their emergency survival kits. Hence a strong market demand on your company’s new canned seafood product is maintained. Russia- Ukraine war is over after negotiations and the shortage of energy no longer persists. The favourable economic condition makes: Unit sales increase by 10%; price per unit increases by 10%; variable cost per unit decreases by 10%; cash fixed cost per year decreases by 10%.
Based on the scenario analysis outcome, draw relevant conclusion about project NPV’s sensitivity.

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