Solutions Manual CHAPTER 21
FI NANCI AL RI SK MANAGEME MENT
SUGGESTED ANSWERS TO THE R EVIEW EVIEW QUESTIONS AND PROBLEMS I.
Questions
1. Refe Referr to to page page 520. 520. 2. Refer Refer to pages pages 520 throug through h 521 521.. 3. Refe Referr to to page page 521. 521. 4. Refer Refer to pages pages 522 throug through h 523 523.. 5. Refer Refer to pages pages 524 throug through h 527 527.. 6. Refe Referr to to page page 532. 532. 7. Refer Refer to pages pages 527 though though 528. 528. 8. Refer Refer to pages pages 537 throug through h 538 538.. 9. Refer Refer to to page pagess 538 538 thro through ugh 539. 539. 10. A decision tree is tree is an analytical tool used in a prole! in "hich a series of decision has to e !ade at #arious ti!e inter#als$ "ith each decision influenced y the infor!ation that is a#ailale at the ti!e it is !ade. %he decision ranches "ill e dra"n as ro&en lines e!erging fro! s'uare nodes and the outco!es of a trail as solid lines e!erging fro! round nodes. %he s'uare nodes$ fro! "hich the decision ranches are dra"n$ represent the points at "hich decision !a&er selects his decision. %he round nodes nodes repres represent ent the point pointss at "hich "hich the outco! outco!ee of the decision arises. %he decision !a&er has no control o#er the outco!e and can only only esti! esti!ate ate the proa proaili ility ty of the #ariou #ariouss outco outco!es !es actua actually lly occurring. (hen all of the decisions and outco!es ha#e een represented on the tree$ each of the possile routes through tree is considered and the !onetary payoff is sho"n at the end of each route. Any costs incurred y the decisions are indicated along the appropriate ranches. II. Multiple Choice Questions Questions
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Financial Risk Management
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2.
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3.
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III. Problems P"o%l!& $
Expected Profit: +roduct , -
0.20 / +8$000 0.10 / +5$000 0.30 +11$000 0.20 +14$000 0.20 +17$000 - +7$400
+roduct
0.15 / +12$000 0.15 / +10$000 0.40 +14$000 0.20 +16$000 0.10 +18$000 - +7$300
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Analysis: *ased on the ao#e data$ the choice "ill e !ade for +roduct ,. P"o%l!& #
a
%o rea&/e#en$ the co!pany !ust earn enough total contriution to co#er its fied costs. %he contriution to fied costs and profits is +2.50 per unit +6 3.5 per unit. %o rea&/e#en$ sales !ust e as follo"s ontriution re'uired ontriution per unit
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+34$000 +2.50
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13$600 units
%he proaility that sales "ill e'ual or eceed 13$600 units is the proaility that sales "ill e 14$000$ 16$000 or 18$000 units$ "hich is 0.25 0.30 0.20 - 0.75 or 75.
%o earn profit of +10$000$ the co!pany !ust earn enough contriution to co#er its fied costs +34$000 and then !a&e the profit$ so total contriution !ust e +44$000. %o earn this contriution$ sales !ust e as follo"s +44$000 +2.50
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17$600 units
%he proaility that sales "ill e'ual or eceed 17$600 units is the proaility of sales eing 18$000 units$ "hich is 0.20 or 20.
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P"o%l!& ' Sales Volume (units)
Probability
0.10 0.30 0.30 0.20 0.10 1.00
Expecte Sales Volume (units)
2$000 6$000 8$000 10$000 14$000
of contriution
200 1$800 2$400 2$000 1$400 7$800
:7$800 12 8;
+31$200 20$000 +11$200
(a) Calculation of expected value of NPV of project !ear
0 16 6 pected =+
Cash Flo"
+ 40$000 11$200 3$000
#CF $ %&'
PV o Cash Flo"
1.0000 4.3550 0.5645
+ 40$000 48$776 1$694 + 10$470
(b) Calculation of minimum volume of sales per annum required to justify te project At rea&/e#en$ the =+ "ould e >ero. %a&ing the cost of the e'uip!ent and its residual #alue$ the !ini!u! re'uired + of annual cash profit "ould e as under + of capital outlay + of residual #alue + of actual cash profit re'uired for =+ of 0
+40$000 1$694 +38$306
)iscount factor of 1 per annu! 6 years ? 10 is 4.355 Annual cash profit re'uired Annual cash fied costs
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+ 8$796 20$000 +28$796
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Annual contriution re'uired for =+ ontriution per unit
0
- +4
ales re'uired to rea&/e#en +28$796 +4
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7$199 units
P"o%l!& ( Annual cash inflo"
+4$500 2.9137
+13$112 12$000 + 1$112
(a) !ensitivity for Project Cost Cf the proBect cost is increased y +1$112$ the =+ of the proBect "ill eco!e >ero. %herefore$ the sensiti#ity for proBect cost is +1$112 +12$000
100
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9.27
(b) !ensitivity for Annual Cas "nflo# Cf the present #alue of annual cash inflo" is lo"er y +1$112$ the =+ of the proBect "ill eco!e >ero. %herefore$ the sensiti#ity for annual cash flo" is +1$112 +13$112
100
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8.48
(c) !ensitivity for Cost of Capital
ero =+ i.e.$ $x% is the CRR / +12$000 +4$500 +4$500
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0 +12$000 +12$000@+4$500 2.6667
Dence$ x - 2.6667 and at 18 for 4 years$ the annuity factor is 2.6667. ensiti#ity
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Analysis: %he cash inflo" is !ore sensiti#e$ since only 8.5 change in cash inflo" "ill !a&e the =+ of the proBect >ero. P"o%l!& ) + of a#ings ear 1 +60$000 0.9259 ear 2 +70$000 0.8573
+ 55$554 60$011 +115$565
+18$518 21$432
39950 75$615 70$000 + 5$615
(a) !ensitivity for Plant Cost Cf the purchase cost of plant increases y +5$615$ the =+ of the proBect "ill eco!e >ero. %herefore$ the sensiti#ity for plant cost is +5$615 +70$000
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8.02
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(b) !ensitivity for &unnin' Cost Cf the present #alue of running cost increases y +5$615$ the =+ of the proBect "ill eco!e >ero. %herefore$ the sensiti#ity for running cost is +5$615 +39$950
100
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14.06
(c) !ensitivity for !avin's Cf the sa#ings decrease y +5$615$ the =+ eco!es >ero. %herefore$ the sensiti#ity for sa#ings is +5$615 +115$565
100
Analysis:
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4.86
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a#ings is the !ost sensiti#e.
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