Risk and project appraisal:
Scenario:
RR Ltd designs and manufacturers women’s clothing. The firm was founded 14 years ago, after a short and successful period as a partnership between Rebecca and Roy Race. The company has grown rapidly and has two successful own brand labels. ‘RR’ catering for the middle-income woman’s market and ‘Racey’ aimed at younger women.
Designs for RR Ltd’s fashion lines are created inhouse and manufacturing takes place across numerous locations in Birmingham, however the company is keen to expand into Asian-Pacific markets and is considering a small manufacturing base in Vietnam.
The project will have an initial outlay of £2m has a 0.55 probability of producing a return of £1.7m in Year 1 and a 0.45 probability of delivering a return of £1m in Year 1. If the £1.7m results occurs, then the second year could return either £2.8m (probability of 0.6) or £1.9m (probability of 0.4). If the £1m result for Year 1 occurs, then either £1.1m (probability 0.5) or £600,000 (probability of 0.5) could be received in the second year. All cash flows occur on anniversary dates. The discount rate for this project is 15%.
Required A:
a) The expected NPV.
b) The standard deviation of NPV.
c) The probability of the NPV being less than zero assuming a normal distribution of return
– (bell shaped and symmetrical about the mean).
Required B:
‘Traditional NPV method is just as effective as an NPV method incorporating probabilities and real option perspectives. (600 words)
Critically evaluate this statement.
– critical perspective through relevant academic referencing.
– evaluate within a practical, real-life business context through investigation of academic empirical findings.
Key words:
– Project and risk appraisal – sensitivity analysis ( ACMART PLC)
– the CAPM as a method for calculating the risk premium.
– Net present value NPV.
– The dividend growth valuation model.
– The Price-Earnings ratio Valuing bonds.
Resources:
– Atrill, P; (2020) ‘Financial Management for Decision Makers’, 9th edition, Pearson. p.358-366
– Watson, D. & Head, A. (2019). Corporate Finance (Principles & Practice). 8th Edition p.252-265
– Chapter 6, 10, 11 and 17 of Arnold, G & Lewis, D; (2019), Corporate Financial Management’Links to an external site., 6th edition, Pearson.
