Solutions Manual

CHAPTER 21-FINANCIAL RISK MANAGEMENT

II. Multiple Choice Questions

1. D 2. D 3. B

Problem 3

ProbabilitySales Volume

(units)Expected Sales Volume (units)

0.10 2,000 2000.30 6,000 1,8000.30 8,000 2,4000.20 10,000 2,000 0.10 14,000 1,4001.00 7,800

EV of contribution [7,800 x (12 – 8)] P31,200Less: Additional fixed overhead 20,000EV 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)1 – 6 11,200 4.3550 48,776

6 3,000 0.5645 1,694Expected 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 P40,000PV of residual value 1,694PV 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 8,796Annual (cash) fixed costs 20,000

P28,796

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Chapter 21 Financial Risk Management

Annual contribution required for NPV = 0

Contribution per unit = P4

Sales required to break-even:

Problem 4

Annual cash inflow (P4,500 x 2.9137) P13,112Less: Project cost 12,000Net 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:

(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:

(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 = 0P4,500 x = P12,000

x = P12,000/P4,500x = 2.6667

Hence, x = 2.6667 and at 18% for 4 years, the annuity factor is 2.6667.

21-2

P28,796P4 = 7,199 units

P1,112P12,000 = 9.27%x 100

P1,112P13,112 = 8.48%x 100

29%18% − 14%

14%= =Sensitivity %

Financial Risk Management Chapter 21

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 SavingsYear 1 (P60,000 x 0.9259) P 55,554Year 2 (P70,000 x 0.8573) 60,011

P115,565Less: PV of Running Cost

Year 1 (P20,000 x 0.9259) P18,518Year 2 (P25,000 x 0.8573) 21,432 39950

Net savings 75,615Less: Purchase cost of plant 70,000Net 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:

(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:

(c) Sensitivity for Savings

If the savings decrease by P5,615, the NPV becomes zero. Therefore, the sensitivity for savings is:

Analysis: Savings is the most sensitive.

21-3

8.02%P5,615P70,000 =x 100

14.06%P5,615P39,950 =x 100

4.86%P5,615

P115,565 =x 100