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Question
NARRBEGIN: SA_51_56A firm is considering investing $0.9M in a typical industrial manufacturing application with a three year production planning cycle under a forecasted market price environment. A simple three-period project pro forma cash flow sheet for this project is shown below:
In the pro forma, the production and price forecast in each period translate to revenue, which can then be netted of production costs to arrive at the expected cash flow in each period. The cash flows are then be discounted at a rate that is commensurate with the riskiness of the project (here, assumed to be 10%).
NARREND
Suppose that the forecasted price levels shown in the pro forma cash flow sheet are not deterministic, but rather are expected to fluctuate due to market forces. The prices are expected to be normally distributed in each year, with the means equal to the expected values shown in the pro forma, but with standard deviations of $5.2, $5.3, and $5.5 in years 1, 2, and 3, respectively. Enter this pro forma in an Excel worksheet, with the appropriate @RISK functions for the random prices, and simulate 1,000 iterations. What is the expected NPV now? Would you recommend investing in this project? Explain.
Answer
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NARREND
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