FIN 486 Expect Success/uophelp.com FIN 486 Expect Success/uophelp.com | Page 30

The media services business is cyclical and highly competitive. The
board of directors has asked you, as chief financial officer, to do the
following:
a.Evaluate the risk of each proposed project and rank it ―low,‖
―medium,‖ or ―high.‖
b.Comment on why you chose each ranking.
P12–3
Breakeven cash inflows and risk Blair Gasses and Chemicals is a
supplier of highly purified gases to semiconductor manufacturers. A
large chip producer has asked Blair to build a new gas production
facility close to an existing semiconductor plant. Once the new gas
plant is in place, Blair will be the exclusive supplier for that
semiconductor fabrication plant for the subsequent 5 years. Blair is
considering one of two plant designs. The first is Blair’s ―standard‖
plant, which will cost $30 million to build. The second is for a
―custom‖ plant, which will cost $40 million to build. The custom
plant will allow Blair to produce the highly specialized gases that are
required for an emerging semiconductor manufacturing process. Blair
estimates that its client will order $10 million of product per year if
the traditional plant is constructed, but if the customized design is put
in place, Blair expects to sell $15 million worth of product annually to
its client. Blair has enough money to build either type of plant, and, in
the absence of risk differences, accepts the project with the highest
NPV. The cost of capital is 12%.
LG 2
a.Find the NPV for each project. Are the projects acceptable?
b.Find the breakeven cash inflow for each project.
c.The firm has estimated the probabilities of achieving various ranges
of cash inflows for the two projects as shown in the following table.
What is the probability that each project will achieve at least the
breakeven cash inflow found in part b?
d.Which project is more risky? Which project has the potentially
higher NPV? Discuss the risk–return trade-offs of the two projects.
e.If the firm wished to minimize losses (that is, NPV < $0), which
project would you recommend? Which would you recommend if the
goal were to achieve a higher NPV?