Sensitivity Analysis - Assignment

ANSWERS
1 Radiant should purchase the specialized equipment and packaging facilities from Donnalley
Limited because it would be $2.6 million cheaper than
Danforth from a cost basis.
2a No, the market testing cost is a sunk cost, hence it is not relevant to include into the future cash
flows.
2
b
No, the annual interest expense should be ignored because cost of financing is accounted for in
the discount rate.
2c Yes, the change in working capital is relevant and hence these cash flows should be recognized.
2
d
Yes, the erosion of sales from current detergents should be included as these will affect the
future revenues, and hence are a cost Radiant will bear should it produce FAB.
2e Yes, the cost of using current excess production facilities and annual rental cost to an outside
firms, should be included as these are opportunity costs arising from utilizing current resources
elsewhere.
3 criterion Decision
NPV $ (311,173) <0; Reject
IRR 10.22% < 15%; Reject
Payback Period 4.56 Accept <5 years
Profitability Index 0.85 < 1; Reject
Radiant should Reject the project
4 Yes, competitive actions may affect future sales revenue, as revenues would be diverted
elsewhere, hence qualitative decisions should be considered alongside any quantitative decisions,
when making project decisions. However, on a
NPV basis, the project should be rejected on an isolation basis.
5a
VARIABLE: NET CASH FLOWS
Scenario Cost of capital NPV
-20% 15% (668,938)
0% 15% (311,173)
20% 15% 46,593

VARIABLE: COST OF CAPITAL
Scenario Cost of capital NPV
-20% -5% 2,100,884
0% 15% (311,173)
20% 35% (1,017,432)
5
b
Minimum -17%
5c NPV -(233,492)
IRR-11.49%
Payback Period-4.35
Profitability Index-0.89
6 Radiant should reject the project on the current basis. However, from the sensitivity analysis, if
they are able to increase net cash flows by at least 17% or are able to reduce their cost of capital
to 10.22% , then they should invest in the project. Furthermore, inflation should be factored into
the cash flows as this will also have an impaction on the NPV
Lastly, quantitative methods such as NPV should not be considered in isolation. Radiant should
also consider other qualitative decisions, such as competitor actions, which may affect future
revenues.

CASH FLOWS
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Operating Revenue 630,000 630,000 660,000 660,000 690,000 690,000 690,000 590,000 590,000 590,000
Less loss of Revenue 90,000 90,000 110,000 110,000 130,000 130,000 130,000 100,000 100,000 100,000
Less operating costs 120,000 120,000 120,000 120,000 120,000 120,000 2,120,000 120,000 120,000 120,000
Operating profit
420,000 420,000 430,000 430,000 440,000 440,000
(1,560,000
) 370,000 370,000 370,000
Less Depreciation Exp 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000
Net Income before tax
(105,000) (105,000) (95,000) (95,000) (85,000) (85,000)
(2,085,000
) (155,000) (155,000) (155,000)
Less Income Tax (31,500) (31,500) (28,500) (28,500) (25,500) (25,500) (625,500) (46,500) (46,500) (46,500)
Net Income after Tax
(73,500) (73,500) (66,500) (66,500) (59,500) (59,500)
(1,459,500
) (108,500) (108,500) (108,500)
Add
Depreciation 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000
Operating ATCF 451,500 451,500 458,500 458,500 465,500 465,500 (934,500) 416,500 416,500 416,500
Working capital (100,000) (75,600) (75,600) (79,200) (79,200) (82,800) (82,800) (82,800) (70,800) (70,800) (70,800)
Change in
Working Capital (100,000) 24,400 0 (3,600) 0 (3,600) 0 0 12,000 0 0
Operating ATCF (100,000) 475,900 451,500 454,900 458,500 461,900 465,500 (934,500) 428,500 416,500 487,300
Initial
Investment (2,000,000)
Terminal ATCF 56,000

ATCF (2,100,000) 475,900 451,500 454,900 458,500 461,900 465,500 (934,500) 428,500 416,500 543,300
Cum ATCF (2,100,000) 475,900 927,400 1,382,300 1,840,800 2,302,700
2,768,20
0 1,833,700 2,262,200 2,678,700 3,222,000
NPV (311,173)
IRR 10.22%
Payback Period 4.56
Profitability
Index 0.85
Solution 5c
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
Operating Revenue 648,900 668,367 721,200 742,836 799,899 823,896 848,613 747,394 769,816 792,911
Less loss of Revenue 92,700 95,481 120,200 123,806 150,706 155,227 159,884 126,677 130,477 134,392
Less operating costs 123,600 127,308 131,127 135,061 139,113 143,286 2,607,333 152,012 156,573 161,270
Operating profit 432,600 445,578 469,873 483,969 510,081 525,383 (1,918,603) 468,705 482,766 497,249
Less Depreciation
Exp 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000
Net Income before
tax (92,400) (79,422) (55,127) (41,031) (14,919) 383 (2,443,603) (56,295) (42,234) (27,751)
Less Income Tax (27,720) (23,827) (16,538) (12,309) (4,476) 115 (733,081) (16,889) (12,670) (8,325)
Net Income after Tax (64,680) (55,595) (38,589) (28,722) (10,444) 268 (1,710,522) (39,407) (29,564) (19,426)
Add Depreciation 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000 525,000
Operating ATCF 460,320 469,405 486,411 496,278 514,556 525,268 (1,185,522) 485,593 495,436 505,574

Working capital (100,000) (77,868) (80,204) (86,544) (89,140) (95,988) (98,868) (101,834) (89,687) (92,378) (95,149)
Change in Working
Capital (100,000) 22,132 (2,336) (6,340) (2,596) (6,848) (2,880) (2,966) 12,146 (2,691) (2,771)
Operating ATCF (100,000) 482,452 467,069 480,071 493,682 507,709 522,388 (1,188,488) 497,740 492,746 597,952
Initial Investment (2,000,000
)
Terminal ATCF 56,000
ATCF
(2,100,000
) 482,452 467,069 480,071 493,682 507,709 522,388 (1,188,488) 497,740 492,746 653,952
Cum ATCF
(2,100,000
) 482,452 949,521 1,429,591 1,923,273 2,430,982 2,953,371 1,764,882 2,262,622 2,755,368 3,409,320
NPV (233,492)
IRR 11.49%
Payback Period 4.35
Profitability Index 0.89