Sensitivity Analysis - Assignment

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Added on 2021-05-31

Sensitivity Analysis - Assignment

Added on 2021-05-31

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ANSWERS1Radiant 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. 2aNo, the market testing cost is a sunk cost, hence it is not relevant to include into the future cash flows.2bNo, 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.2dYes, 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.2eYes, 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.3criterionDecisionNPV $ (311,173)<0; RejectIRR10.22%< 15%; RejectPayback Period4.56 Accept <5 yearsProfitability Index0.85 < 1; RejectRadiant should Reject the project4Yes, 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.5aVARIABLE: NET CASH FLOWSScenarioCost of capitalNPV-20%15%(668,938)0%15%(311,173)20%15%46,593

VARIABLE: COST OF CAPITALScenarioCost of capitalNPV-20%-5%2,100,884 0%15%(311,173)20%35%(1,017,432)5bMinimum -17%5cNPV -(233,492)IRR-11.49%Payback Period-4.35Profitability Index-0.896Radiant 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 NPVLastly, 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.

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