Solutions Manual

CHAPTER 21-FINANCIAL RISK MANAGEMENT

II. Multiple Choice Questions

1. D 2. D 3. B

Problem 3

Sales Volume Expected Sales

Probability (units) Volume (units)
0.10 2,000 200
0.30 6,000 1,800
0.30 8,000 2,400
0.20 10,000 2,000
0.10 14,000 1,400
1.00 7,800

EV of contribution [7,800 x (12 8)] P31,200

Less: Additional fixed overhead 20,000
EV of additional cash profit per annum P11,200

(a) Calculation of expected value of NPV of project

Year Cash Flow DCF @ 10% PV of Cash Flow

0 P (40,000) 1.0000 P (40,000)
16 11,200 4.3550 48,776
6 3,000 0.5645 1,694
Expected NPV P 10,470

(b) Calculation of minimum volume of sales per annum required to justify the project

At break-even, the NPV would be zero. Taking the cost of the equipment and its residual value, the
minimum required PV of annual cash profit would be as under:

PV of capital outlay P40,000

PV of residual value 1,694
PV of actual cash profit required for NPV of 0 P38,306

Discount factor of 1 per annum 6 years @ 10% is 4.355

Annual cash profit required (P38,306/4.355) P 8,796

Annual (cash) fixed costs 20,000
P28,796
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Annual contribution required for NPV = 0

Contribution per unit = P4
Sales required to break-even:
P28,796
P4 = 7,199 units

Problem 4

Annual cash inflow (P4,500 x 2.9137) P13,112

Less: Project cost 12,000
Net present value P 1,112

(a) Sensitivity for Project Cost

If the project cost is increased by P1,112, the NPV of the project will become zero. Therefore, the sensitivity
for project cost is:
P1,112
P12,000 x 100 = 9.27%

(b) Sensitivity for Annual Cash Inflow

If the present value of annual cash inflow is lower by P1,112, the NPV of the project will become zero.
Therefore, the sensitivity for annual cash flow is:
P1,112
P13,112 x 100 = 8.48%

(c) Sensitivity for Cost of Capital

Let x be the annuity factor which gives a zero NPV (i.e., x is the IRR)

- P12,000 + P4,500 x = 0
P4,500 x = P12,000
x = P12,000/P4,500
x = 2.6667
Hence, x = 2.6667 and at 18% for 4 years, the annuity factor is 2.6667.

18% 14%
Sensitivity % = 14% = 29%

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Analysis:
The cash inflow is more sensitive, since only 8.5% change in cash inflow will make the NPV of the project
zero.

Problem 5

PV of Savings
Year 1 (P60,000 x 0.9259) P 55,554
Year 2 (P70,000 x 0.8573) 60,011
P115,565
Less: PV of Running Cost
Year 1 (P20,000 x 0.9259) P18,518
Year 2 (P25,000 x 0.8573) 21,432 39950
Net savings 75,615
Less: Purchase cost of plant 70,000
Net present value P 5,615

(a) Sensitivity for Plant Cost

If the purchase cost of plant increases by P5,615, the NPV of the project will become zero. Therefore, the
sensitivity for plant cost is:
P5,615
P70,000 x 100 = 8.02%

(b) Sensitivity for Running Cost

If the present value of running cost increases by P5,615, the NPV of the project will become zero.
Therefore, the sensitivity for running cost is:
P5,615
P39,950 x 100 = 14.06%

(c) Sensitivity for Savings

If the savings decrease by P5,615, the NPV becomes zero. Therefore, the sensitivity for savings is:
P5,615
P115,565 x 100 = 4.86%

Analysis: Savings is the most sensitive.

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