Dynamic Strategic Planning - Problem Sets

2. Economic Evaluation of Projects

 

 

Problem 2.1

Your company is planning to build a new power plant of 500 MW. You are analyzing two alternatives fuel sources: coal or gas.

The payoffs for your investment are uncertain because new environmental law may be enacted which will affect the profitability of coal. Table 1 summarizes the return from your investments for the possible scenarios.

Technology

Initial investment (in $M)

Yearly net cash flow (in $M)

Scenario 1: new environmental law is enacted

Coal

100

10

Gas

200

40

Scenario 2: new environmental law is not enacted

Coal

100

30

Gas

200

40

Your discount rate is 15%.

  1. Assume that you have to spend your investment immediately, but that your revenues start at the end of the first period. Draw the cash flow diagram for the gas-powered plant.
  2. Assume that the revenues last at least 25 years. Estimate the approximate value of each of the possible outcomes.

 

Problem 2.2

Your company is planning to introduce a new car in the market. You are analyzing two alternatives:

The hybrid car is more expensive to manufacture and the payoffs for the investment are uncertain, because it is a new product and you do not know for sure how the market will react to it. Table 1 summarizes the returns from your investments for the possible scenarios.

Technology

Initial investment (in $M)

Yearly net cash flow (in $M)

Conventional ICE

150

30

Scenario 1: positive reaction from the market to the hybrid

Hybrid

250

60

Scenario 2: negative reaction from the market to the hybrid

Hybrid

250

25

Your discount rate is 15%.

  1. Assume that you have to spend your investment immediately, but that your revenues start at the end of the first period. Draw the cash flow diagram for the conventional ICE car.
  2. Assume that the revenues last at least 25 years. Estimate the approximate value of each of the possible outcomes.

 

Problem 2.3

PDQ, the Express Company is looking at the Mars and Moon workstations for possible purchases:

 

Mars

Moon

Initial Cost

40

60

Annual Cost

27

21

Salvage value in 5 years

10

8

PDQs financial situation is:

 

  1. Calculate the present value for both machines assuming a discount rate of 10%, 15%.
  2. Discuss the sensitivity of the ranking of the workstations to the discount rate
  3. What discount rate should it use in evaluating its workstation purchase?
  4. Discuss the role of inflation in this analysis.
  5. PDQs present system has an annual cost of 39. Evaluate the workstation options by NPV, B/C, and Payback Period.
  6. Discuss the relative merits of these three criteria of evaluation, with reference to PDQs problem and more generally.

 

Problem 2.4

Calculate the net present value of a prospective investment of $100,000 that will pay back $200,000 in 4 years, for a company that can invest $200,000 and has the other investment opportunities displayed in the table below. Should the company make this investment?

Project

Investment ($)

Annual Return (%)

A

50,000

14

B

40,000

21

C

85,000

11

D

40,000

23

E

70,000

16

F

40,000

20

G

90,000

18

H

20,000

25

 

Problem 2.5

October 28, 1999. As often at that time, you are out of money and welcome the end of the month and your $3,500 pay. Except for the rent ($1,000) and for the $800 that will have to be available on the checking account for your monthly expenses, you are wondering how to make the best use of your money:

While having a drink with your best friend, you find out that you have won $1,000 in a lottery. Your friend jumps on the occasion, and asks you to lend him the $1,000.

  1. Define the discount rate.
  2. Assuming that you do not want to take advantage of your friend and make a profit, but do not want to loose anything in the transaction either, how much would you ask your friend to pay you back in a year?