Question

Simulation

Singleton Supplies Corporation (SSC) manufactures medical products for hospitals, clinics, and nursing homes. SSC may introduce a new type of X-ray scanner designed to identify certain types of cancers in their early stages. There are a number of uncertainties about the proposed project, but the following data are believed to be reasonably accurate.

Probability	Developmental costs	Random Numbers
0.3	$2,000,000	00-29
0.4	4,000,000	30-69
0.3	6,000,000	70-99

Probability	Project Life	Random Numbers
0.2	3 years	00-19
0.6	8 years	20-79
0.2	13 years	80-99

Probability	Sales in Units	Random Numbers
0.2	100	00-19
0.6	200	20-79
0.2	300	80-99

Probability	Sales Price	Random Numbers
0.1	$12,500	00-09
0.8	13,000	10-89
0.1	13,500	90-99

Probability	Cost per Unit (Excluding Developmental Costs)	Random Numbers
0.3	$5,000	00-29
0.4	6,000	30-69
0.3	7,000	70-99

SSC uses a cost of capital of 13% to analyze average-risk projects, 10% for low-risk projects, and 16% for high-risk projects. These risk adjustments primarily reflect the uncertainty about each project's NPV and IRR as measured by their coefficients of variation. The firm is in the 40% federal-plus-state income tax bracket.

1. What is the expected IRR for the X-ray scanner project? Base your answer on the expected values of the variables. Also, assume the after-tax "profits" figure that you develop is equal to annual cash flows. All facilities are leased, so depreciation may be disregarded. Do not round intermediate calculations. Round the answer to two decimal places.

     %

   Can you determine the value of σ_IRR short of actual simulation or complex statistical analysis?

   -Select-NoYesItem 2

2. Assume that SSC uses a 13% cost of capital for this project. What is the project's NPV? Do not round intermediate calculations. Round the answer to the nearest cent.

   $  

   Could you estimate σ_NPV without either simulation or a complex statistical analysis?

Answer 1

a)

Calculation of Cash Inflow

Particulars	Amount
Sales (in units)	200 Units
Sales Price	$13,000
Sales Revenue	$2,600,000
Less : Costs (200 * $6000)	($1,200,000)
Earning before Tax	$1,400,000
Less : Tax @40%	($560,000)
Net Cash Inflow	$840,000

Cash Outflow = $4,000,000

Present value of Cash Inflow = $840,000 * PVAF (13%, 8 years)

= $4,030,992

IRR is the rate at which NPV is '0'

IRR = 13.23%

b) NPV = Present value of Cash Inflows - Present Value of Cash Outflows

= $4,030,992 - $4,000,000

= $30,992