Solutions Manual

CHAPTER 21-FINANCIAL RISK MANAGEMENT

II. Multiple Choice Questions
1.

2.

3.

Problem 3
Probability
0.10
0.30
0.30
0.20
0.10
1.00

Sales Volume
(units)

Expected Sales
Volume (units)

2,000
6,000
8,000
10,000
14,000

200
1,800
2,400
2,000
1,400
7,800

EV of contribution
Less: Additional fixed overhead
EV of additional cash profit per annum

[7,800 x (12 8)]

P31,200
20,000
P11,200

(a) Calculation of expected value of NPV of project

Year
0
16
6
Expected NPV

Cash Flow
P (40,000)
11,200
3,000

DCF @ 10%

PV of Cash Flow

1.0000
4.3550
0.5645

P (40,000)
48,776
1,694
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
PV of residual value
PV of actual cash profit required for NPV of 0

P40,000
1,694
P38,306

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

Annual cash profit required
Annual (cash) fixed costs

(P38,306/4.355)

P 8,796
20,000
P28,796
21-1

Chapter 21

Financial Risk Management

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
Less: Project cost
Net present value

(P4,500 x 2.9137)

P13,112
12,000
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

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

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
P4,500 x
x
x

=
=
=
=

0
P12,000
P12,000/P4,500
2.6667

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

18% 14%
14%

29%
21-2

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 Savings
Year 1 (P60,000 x 0.9259)
Year 2 (P70,000 x 0.8573)

P 55,554
60,011
P115,565

Less: PV of Running Cost

Year 1 (P20,000 x 0.9259)
Year 2 (P25,000 x 0.8573)
Net savings
Less: Purchase cost of plant
Net present value

P18,518
21,432

39950
75,615
70,000
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

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

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

100

4.86%

Analysis: Savings is the most sensitive.

21-3