15 Park ISM ch15 PDF

15-1
Chapter 15 Project Risk and Uncertainty

Sensitivity Analysis
*
15.1
(a) and (b) Project cash flows based on most likely estimates:
total CCA $60,218

UCC4 $24,782
G 0.4($30,000 24,782) $2,087
After-tax Net Cash Flow

(a) (b)
Without With
n Working Capital Working Capital
0 $85,000 $87,000
1 24,300 24,300
2 27,870 27,870
3 25,269 25,269
4 51,361 53,361
PW(15%) $3,185 $2,238
The project is acceptable in either situation.
(c) Required annual savings (X):
$85,000 (0.6X)(P /A, 20%, 4) + $5,100(P /F , 20%, 1) +

$8,670(P /F , 20%, 2) + $6,069(P /F , 20%, 3) +
$32,161(P /F , 20%, 4)
X $35,865
15.2
Projects IRR if the investment is made now:
PW (i ) $500,000 $200,000(P / A, i, 5) 0
i 28.65%
Let X denote the additional after-tax annual cash flow:
*
An asterisk next to a problem number indicates that the solution is available to students
on the Companion Website.
Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

15-2
PW (28.65%) $500, 000 X ( P /A, 28.65%, 4)( P /F , 28.65%, 1) 0

X $290, 240
15.3
(a) Economical building height:
0% < i < 20%: The optimal building height is five floors.
20% < i < 30%: The optimal building height is two floors.
Net Cash Flows

n 2 Floors 3 Floors 4 Floors 5 Floors
0 ($500,000) ($750,000) ($1,250,000) ($2,000,000)
1 199,100 169,200 149,200 378,150
2 199,100 169,200 149,200 378,150
3 199,100 169,200 149,200 378,150
4 199,100 169,200 149,200 378,150
5 799,100 1,069,100 2,149,200 3,378,150
Sensitivity Analysis
PW(i) as a Function of Interest Rate
Best
i(%) Floor Plan
5 $832,115 $687,643 $963,010 $1,987,770 5
6 787,037 635,190 873,001 1,834,680 5
7 744,141 585,370 787,722 1,689,448 5
8 703,298 538,023 706,879 1,551,593 5
9 664,388 493,002 630,199 1,420,666 5
10 627,298 450,168 557,428 1,296,250 5
11 591,924 409,393 488,330 1,177,957 5
12 558,167 370,556 422,686 1,065,427 5
13 525,937 333,545 360,291 958,321 5
14 495,148 298,257 300,953 856,326 5
15 465,720 264,594 244,495 759,148 5
16 437,580 232,465 190,751 666,513 5
17 410,657 201,784 139,565 578,166 5
18 384,885 172,472 90,792 493,867 5
19 360,205 144,454 44,298 413,393 5
20 336,557 117,661 (46) 336,533 2
21 313,889 92,027 (42,357) 263,091 2
22 292,150 67,490 (82,746) 192,883 2
23 271,292 43,993 (121,319) 125,737 2
24 251,271 21,482 (158,173) 61,490 2
25 232,044 (95) (193,399) (9) 2
26 213,572 (20,784) (227,084) (58,903) 2
27 195,817 (40,632) (259,308) (115,327) 2
28 178,745 (59,679) (290,148) (169,407) 2

15-3
29 162,323 (77,967) (319,674) (221,261) 2

30 146,519 (95,532) (347,955) (271,002) 2
(b) Effects of overestimation on resale value:
Net Present Worth

Number of Floors
Resale 2 3 4 5
Value
Base $465,720 $264,594 $244,495 $759,148
10% error 435,890 219,898 145,060 609,995
Difference $29,831 $44,696 $99,435 $149,153
15.4
(a) Defender:
0 1 2 3 4 5 6
Revenue
Expenses
O&M 5,000 5,000
5,000 5,000 5,000 5,000
CCA 3,499 2,449
1,714 1,200 840 588
Taxableincome (8,499) (7,449)
(6,714) (6,200) (5,840) (5,588)
Incometaxes (3,399) (2,980)
(2,686) (2,480) (2,336) (2,235)
Netincome (5,099) (4,469)
(4,029) (3,720) (3,504) (3,353)
CashFlowStatement
Operatingactivities
Netincome (5,099) (4,469) (4,029) (3,720) (3,504) (3,353)
CCA 3,499 2,449 1,714 1,200 840 588
Investmentactivities:
Salvage (6000) (500)
Disposaltaxeffect (2265) 749
NetCashFlow (8265) (1601) (2020) (2314) (2520) (2664) (2516)
UCC0 = $40,000(1 0.15)(1 0.30)3 = $11,662
Challenger:
0 1 2 3 4 5 6
Revenues
Expenses:
O&M $1,000 $1,000 $1,000 $1,000 $1,000 $1,000
CCA 3,750 6,375 4,463 3,124 2,187 1,531
Taxable income (4,750) (7,375) (5,463) (4,124) (3,187) (2,531)
Income taxes (40%) (1,900) (2,950) (2,185) (1,650) (1,275) (1,012)
Net income ($2,850) ($4,425) ($3,278) ($2,474) ($1,912) ($1,518)
Cash Flow Statement

15-4
Operating activities:
Net income ($2,850) ($4,425) ($3,278) ($2,474) ($1,912) ($1,518)
CCA 3,750 6,375 4,463 3,124 2,187 1,531
Investment activities:
Investment ($25,000)
Salvage 2,000
Disposal tax effect 629
Net cash flow ($25,000) $900 $1,950 $1,185 $650 $275 $2,641
Incremental cash flows:
NetCashFlow Incremental
Challenger Defender CashFlow
n C D (CD)
0 25000 8265 16735
1 900 1601 2501
2 1950 2020 3970
3 1185 2314 3499
4 650 2520 3169
5 275 2664 2939
6 2641 2516 5157
PW(10%)= 19575 17924 1651
IRR= 6.77%
The defender should be retained.
(b) Sensitivity analysis: If the operating costs of the defender inflate by 9% per
year, it becomes preferable to replace with the challenger now. (IRRC D =
14.75%; PW(10%)C D = $2,719)
(c) Break-even trade-in value: Let X denote the change (positive or negative) in
sale price for the defender which would result in the same PW for the
defender and challenger. At time 0, the firm would receive X dollars more
(or less) for the defender, and the immediate disposal tax effect would be
altered by t X (so if X is positive more tax is owed, and vice versa if X is
negative):
PWD + (1 t)X = PWC
Therefore:
X = ( 19,575 + 17,924)/0.6 = $2,752
So if the current sale price were $6,000 $2,752 = $8,752, we would be

indifferent to replacing the defender now.

15-5
15.5
(a)
Option 1: Copper wire:
cost per metre $5.55

cost per pair $0.043
number of pairs 2,000
lengths 8,000 metres
first cost ($5.55 + $0.043 2,000) 8,000 metres $732,400
annual cost 0.184 $732,400 $134,761.60
PW (15%)1 $1,617,242
Option 2: Fibre optics:
Requirements:
1 repeater, 21 modulators in central office, 21 modulators in field
ribbon cost $74,568

terminator cost $240,000
repeater cost $15,000
modulating system cost $1,428,000
total first cost $1,757,568
annual cost modulators $178,500
annual cost ribbon $13,273
total annual cost $191,773
PW (15%)2 $3,016,746
Option 1 is the better choice since PW1 > PW2.
(b) Either 16 km or 40 km of transmission distance:

16 km:
PW (15%)1 $3,234,484
PW (15%)2 $3,193,465
Option 2 is the better choice by a slight margin.

15-6
40 km:
PW (15%)1 $8,086,210
PW (15%)2 $3,723,622
Option 2 is the better choice.

*
15.6
(a) With infinite planning horizon: We assume that both machines will be
available in the future with the same cost. (Select Model A.)
Model A:
t = 0.3 d = 0.3
MARR = 0.1 n = 8
Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenue
O&M cost 700 700 700 700 700 700 700 700
CCA 900 1,530 1,071 750 525 367 257 180
Taxable income (1,600) (2,230) (1,771) (1,450) (1,225) (1,067) (957) (880)
Income tax (480) (669) (531) (435) (367) (320) (287) (264)
Net income (1,120) (1,561) (1,240) (1,015) (857) (747) (670) (616)
Cash Flow Statement
Cash from operations:
Net income (1,120) (1,561) (1,240) (1,015) (857) (747) (670) (616)
CCA 900 1,530 1,071 750 525 367 257 180
Investment (6,000)
Salvage 500
Disposal tax effect (24)
Working capital
Net cash flow (6,000) (220) (31) (169) (265) (333) (380) (413) 40
Undepreciated capital cost 6,000 420
PW = $(7,148)
AE = $(1,340)

15-7
Model :
t = 0.3 d = 0.3
MARR = 0.1 n = 10
Year 0 1 2 3 4 5 6 7 S 9 10
Income Statement
Revenue
O&M cost 520 520 520 520 520 520 520 520 520 520
CCA 1,275 2,168 1,517 1,062 743 520 364 255 179 125
Taxable income (1,795) (2,688) (2,037) (1,582) (1,263) (1,040) (884) (775) (699) (645)
Income tax (539) (806) (611) (475) (379) (312) (265) (233) (210) (193)
Net income (1,257) (1,881) (1,426) (1,107) (884) (728) (619) (543) (489) (451)
Cash Flow
Statement
Cash from
operations:
Net income (1,257) (1,881) (1,426) (1,107) (884) (728) (619) (543) (489) (451)
CCA 1,275 2,168 1,517 1,062 743 520 364 255 179 125
Investment (8,500)
Salvage 1,000
Disposal tax effect (213)
Working capital
Net cash flow (8,500) 19 286 91 (45) (141) (208) (255) (287) (310) 461
Undepreciated 8,500 292
capital cost
PW = $(8,633)
AE = $(1,405)
Model A is a better choice since it is cheaper.
(b) Break-even annual O&M costs for machine A: Let X denote a before-tax
annual operating cost for model.
PW (10%) A $6,000 + ($270 0.7X)(P /F , 10%, 1) + ... +

($459 0.7X )(P /F , 10%, 8)
$4,533 3.734X
AE (10%) A $850 0.7X
Let (10%) = AE(10%)B, and solve for X.
$850 0.7X $1,405

X $793 per year

15-8
(c) With a shorter service life:
Net Cash Flow

n Model A Model B
0 $6,000 $8,500
1 220 19
2 31 286
3 169 91
4 265 45
5 2,135 2,829
PW(10%) $5,208 $6,452
Model A is still preferred over Model B.
15.7 (a) and (b):
Alternative #1
OR = 7915748 Labour = 261040 O&M = 1092000 Changed = 1
MARR = 0.18 t = 0.4 d = 0.3 n = 8
Year 0 1 2 3 4 5 6 7 8
Income
Statement
Revenue 7,915,748 7,915,748 7,915,748 7,915,748 7,915,748 7,915,748 7,915,748 7,915,748
Labour cost 261,040 261,040 261,040 261,040 261,040 261,040 261,040 261,040
O&M cost 1,092,000 1,092,000 1,092,000 1,092,000 1,092,000 1,092,000 1,092,000 1,092,000
CCA 321,905 547,239 383,067 268,147 187,703 131,392 91,974 64,382
Taxable income 6,240,803 6,015,469 6,179,641 6,294,561 6,375,005 6,431,316 6,470,734 6,498,326
Income tax 2,496,321 2,406,188 2,471,856 2,517,824 2,550,002 2,572,526 2,588,293 2,599,330
Net income 3,744,482 3,609,281 3,707,784 3,776,736 3,825,003 3,858,790 3,882,440 3,898,996
Cash Flow
Statement
Cash from
operations:
Net income 3,744,482 3,609,281 3,707,784 3,776,736 3,825,003 3,858,790 3,882,440 3,898,996
CCA 321,905 547,239 383,067 268,147 187,703 131,392 91,974 64,382
Investment (2,146,036)
Salvage 62,000 169,000
Disposal tax (24,800) (7,510)
effect
Net cash flow (2,108,836) 4,066,387 4,156,520 4,090,852 4,044,884 4,012,706 3,990,182 3,974,415 4,124,868
Undepreciated
capital cost 2,146,036 150,225
PW = $14,475,648
AE = $3,550,071
IRR = 1.938%

15-9
Alternative #2
OR = 7455084 Labour = 422080 O&M = 1560000 Changed = 1
MARR = 0.18 t = 0.4 d = 0.3 n = 8
Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenue 7,455,084 7,455,084 7,455,084 7,455,084 7,455,084 7,455,084 7,455,084 7,455,084
Labour cost 422,080 422,080 422,080 422,080 422,080 422,080 422,080 422,080
O&M cost 1,560,000 1,560,000 1,560,000 1,560,000 1,560,000 1,560,000 1,560,000 1,56,0000
CCA 168,036 285,662 199,963 139,974 97,982 68,587 48,011 33,608
Taxable income 5,304,968 5,187,342 5,273,041 5,333,030 5,375,022 5,404,417 5,424,993 5,439,396
Income tax 2,121,987 2,074,937 2,109,216 2,133,212 2,150,009 2,161,767 2,169,997 2,175,758
Net income 3,182,981 3,112,405 3,163,824 3,199,818 3,225,013 3,242,650 3,254,996 3,263,638
Cash Flow Statement
Net income 3,182,981 3,112,405 3,163,824 3,199,818 3,225,013 3,242,650 3,254,996 3,263,638
CCA 168,036 285,662 199,963 139,974 97,982 68,587 48,011 33,608
Investment (1,120,242)
Salvage 62,000 54,000
Disposal tax effect (24,800) 9,767
Net cash flow (1,083,042) 3,351,017 3,398,067 3,363,788 3,339,792 3,322,995 3,311,237 3,303,007 3,361,013
Undepreciated
capital cost 1,120,242 78,418
PW = $12,577,327
AE = $3,084,519
IRR = 3.102%
Sensitivity graphs:
This figure shows that the PW is not very sensitive to operating costs (labour or O&M).
While its somewhat sensitive to MARR, this is not a significant issue as its the
company that sets their threshold for rate of return. The present worth is quite sensitive to

15-10
sales level; however, Alternative 1 remains feasible even for a drop in sales of 30%.
Similar charts can be prepared for Alternative 2, and for the difference in their PWs.
15.8 Sensitivity graph:
Break-Even Analysis
15.9
PW of net investment:
P0 = $2,200,000 $600,000 $400,000 = $3,200,000
PW of after-tax revenue:
P1 $4,000(365)X (1 0.31)(P /A, 10%, 25)

$9,144,210X
PW of after-tax operating costs:
P2 ($230,000 + $170,000X )(1 0.31)(P/A, 10%, 25)

$1,440,526 1,064,737X

15-11
PW of tax savings due to capital cost allowance:
CCA on CCA on CCA Tax Savings

n Building Furniture Total (t = 31%)
1 $44,000 $40,000 $84,000 $26,040
2 86,240 72,000 158,240 49,054
3 82,790 57,600 140,390 43,521
4 79,479 46,080 125,559 38,923
5 76,300 36,864 113,164 35,081
6 73,248 29,491 102,739 31,849
7 70,318 23,593 93,911 29,112
8 67,505 18,874 86,379 26,778
9 64,805 15,099 79,904 24,770
10 62,213 12,080 74,292 23,031
11 59,724 9,664 69,388 21,510
12 57,335 7,731 65,066 20,170
13 55,042 6,185 61,227 18,980
14 52,840 4,948 57,788 17,914
15 50,726 3,958 54,685 16,952
16 48,697 3,167 51,864 16,078
17 46,750 2,533 49,283 15,278
18 44,880 2,027 46,906 14,541
19 43,084 1,621 44,706 13,859
20 41,361 1,297 42,658 12,224
21 39,707 1,038 40,744 12,631
22 38,118 830 38,948 12,074
23 36,594 664 37,258 11,550
24 35,130 531 35,661 11,055
25 33,725 425 34,150 10,586
P3 $26,040(P / F , 10%, 1) + $49,054(P / F , 10%, 2) + ... +

$10,586(P / F , 10%, 25)
$258,260
PW of net proceeds from sale of capital assets:
Disposal Capital
Property Cost Salvage Undepreciated Tax Effect Gains Tax Net
(Asset) Base Value Capital Cost G = t (U 0.75 t salvage
S) (S P)
Furniture $400,000 $0 $1,700 $527 None $527
Building 2,200,000 0 809,391 250,911 None 250,911
Land 600,000 2,031,813 600,000 None (332,897) 1,698,916

15-12
net proceeds from sale $527 + $250,911 + $1,698,354

$1,950,354
P4 $1,950,354(P/F , 10%, 25)
$180,010
PW (10%) P0 + P1 + P2 + P3 + P4
$4,202,256 + 8,079,473X
0
X 52.01%
15.10 Useful life of the old bulb: 13,870/(19 365) = 2 years
Therefore, the new bulb would last for four years. Let X denote the price for
the new light bulb. With an analysis period of four years, we can compute
the present equivalent for each option as follow:
PW (15%)old (1 0.40) $61.90 [1 (P /F , 15%, 2)]

$65.23
PW (15%) new (1 0.40)(X $16)
The break-even price for the new bulb will be
0.6X 9.6 $65.23

X $92.72
Since the new light bulb costs only $60, it is a good bargain.
*
15.11
PW of net investment:
P0 = $250,000
PW of after-tax rental revenue (where X is the annual rental income):
P1 X (1 0.30)(P / A, 15%, 20)

$4.3815X
PW of after-tax operating costs:

P2 (1 0.30)$12,000(P/A, 15%, 20)
$52,578
PW of the investment and tax effects:
n CCABuilding Tax Savings (30%)

15-13
1 $5,000 $1,500
2 9,800 2,940
3 9,408 2,822
4 9,032 2,710
5 8,670 2,601
6 8,324 2,497
7 7,991 2,397
8 7,671 2,301
9 7,364 2,209
10 7,070 2,121
11 6,787 2,036
12 6,515 1,955
13 6,255 1,876
14 6,005 1,801
15 5,764 1,729
16 5,534 1,660
17 5,312 1,594
18 5,100 1,530
19 4,896 1,469
20 4,700 1,410
Total CCA = 137,197
P3 $1,500(P / F , 15%, 1) + $2,940(P / F , 15%, 2) + +

$1,410(P / F , 15%, 20 )
$14,324
PW of net proceeds from sale of building:

total CCA $139,137
undepreciated capital cost $250,000 $139,137 $112,803
salvage value $250,000(1.05)20 $663,324
disposal tax effect 0.30($112,803 $250,000) 0.75 0.30
($663,324 $250,000) $134,157
net proceeds from sale $663,324 $134,157 $529,167
P4 $529,167(P /F , 15%, 20) $32,332

15-14
The break-even rental:
PW (10%) P0 + P1 + P2 + P3 + P4
$255,922 + $4.3815X
0
X $58,410
15.12 Let X denote the additional annual revenue (above $16,000) for Model A
that is required to break even.
Generalized cash flows for Model A:
Cash flow elements 0 1 2 3 4 5 6

(0.40)CCAn $4,800 $8,160 $5,712 $3,998 $2,799 $1,959
(0.60)O&Mn (13,200) (13,200) (13,200) (13,200) (13,200) (13,200)
+(0.60)Rn 9,600 9,600 9,600 9,600 9,600 9,600
+0.6X +0.6X +0.6X +0.6X +0.6X +0.6X
Net salvage 16,572
Net cash flow ($80,000) $1,200 $4,560 $2,112 $398 ($801) $14,931
+0.6X +0.6X +0.6X +0.6X +0.6X +0.6X
PW (20%) A $80,000 + 0.6X (P /A, 20%, 6) + $1,200(P /F , 20%, 1) + ... +

$14,931(P / F , 20%, 6)
$69,741 + 1.9953X
Generalized cash flows for Model B:
Cash flow elements 0 1 2 3 4 5 6

(0.40)CCAn $3,120 $5,304 $3,713 $2,599 $1,819 $1,273
(0.60)O&Mn (10,200) (10,200) (10,200) (10,200) (10,200) (10,200)
+(0.60)Rn 0 0 0 0 0 0
Net salvage 11,971
Net cash flow ($52,000) ($7,080) ($4,896) ($6,487) ($7,601) ($8,381) ($3,045)
PW (20%) B $52,000 $7,080(P/F , 20%, 1) + ... + $3,045(P/F , 20%, 6)

$71,068
Now let PW(20%) = PW(20%)B and solve for X.

$69,741 + 1.9953X $71,068
X $665

15-15
The required break-even annual revenue for Model A is then
$16,000 + X = $15,335
15.13 Let X denote the number of copies to break even.
A/T annual revenue (0.6)[$0.20 + ($1.00 $0.20)]X

0.60X
A/T O&M cost (0.60)[$1,200,000(12) $0. 40X ]
$8,640,000 0.24X
CCA tax savings 0.4[$180,000(P /F , 13%, 1) + ... +
$17,640(P /F , 13%, 10)](A/P, 13%, 10)
$57,542
net salvage value 0.40($41,161 $200,000) + $200,000
$136,464
CR(13%) $1,200,000(A/P, 13%, 10) + $136,464(A/F , 13%, 10)
$213,739
AE (13%) 0.60X $8,640,000 0.24X + $57,542 $213,739
0
X 24,433,880 copies per year
or 81,446 copies per day (300 days per year)
Probabilistic Analysis
15.14
PW (12%)light $8,000,000 + $1,300,000(P /A, 12%, 3)

$4,800,000
PW (12%) moderate $8,000,000 + $2,500,000(P /A, 12%, 4)
$406,627
PW (12%) high $8,000,000 + $4,000,000(P /A, 12%, 4)
$4,149,000
E[PW (12%)] $4,800,000(0.20) $406,627(0.40) + $4,149,000(0.40)
$536,947
Yes, the company should make this investment.

15-16
15.15
(a) The PW distribution for Project 1:
Event (x, y) Joint Probability PW (10%)

($20,$10) 0.24 $8,000
($20,$20) 0.36 $16,000
($40,$ 10) 0.16 $32,000
($40,$20) 0.24 $64,000
(b) The mean and variance of the NPW for Project 1:
E[PW (10%)]1 $8,000(0.24) + $16,000(0.36) + $32,000(0.16)

+$64,000(0.24)
$28,160
Var[PW (10%)]1 (8,000 28,160) 2 (0.24) + (16,000 28,160) 2 (0.36)
+ (32,000 28,160) 2 (0.16) + (64,000 28,160) 2 (0.24)
461,414,400
(c) The mean and variance of the NPW for Project 2:
E[PW (10%)]2 $8,000(0.24) + $16,000(0.20) + $32,000(0.36)

+ $64,000(0.20)
$32,000
Var[PW (10%)]2 (8,000 32,000) 2 (0.24) + (16,000 32,000) 2 (0.20)
+ (32,000 32,000) 2 (0.36) + (64,000 32,000) 2 (0.20)
394,240,000
(d) Project 2 is preferred over Project 1 because its mean is greater than that of
Project 1 but its variance is smaller than that of Project 1.
15.16
(a) Expected value criterion: Assume that the inventors opportunity cost rate is
7.5%.
Option 1:
E[R]1 = $2,450(0.25) + $2,000(0.45) + $1,675(0.30) $150(F/P, 7.5%, 1)

$1,854

15-17
Option 2:
E[R]2 = $25,000(0.075) = $1,875
Option 2 is the better choice based on the principle of expected value

maximization.
(b) We need to make an explicit assumption about the reliability of the

investment firm. If the investment firm tells the investor with certainty that
the bonds yield will be $2,450, the investors strategy would be to
purchase the bond. After paying $150 brokerage fee (which is worth about
$161 at 7.5% at the end of year 1), his net gain is $2,289. If the investment
firm tells him otherwise, his best strategy would be to buy the GIC. Before
receiving the perfect information from the investment firm, he can calculate
the expected profit with perfect information. This is done by summing for
each possible state; the probability that a particular state will occur
multiplied by the maximum net gain achievable for that state.
expected net gain ($2,289 $1,875)(0.25) + $0(0.45) + $0(0.30)

$104
The investor should not solicit professional advice at any expense higher
than $104(P/F, 7.5%, 1) = $96 in todays dollars.
15.17 Let X denote the annual revenue in constant dollars and Y the annual general
inflation rate. Then is defined as (1 + Y).
(a) PW as a function of X and Z:
Cash Element End of Period

0 1 2
Investment $9,000
Salvage value 4,000Z2
Disposal tax effect 0.40(5,355 4,000Z2)
(0.4)CCAn 540 2,142
(0.6)Rn 0.6XZ 0.6XZ2
Working capital 2,000 2,000(1 Z) 2,000Z
Net cash flow $11,000 2,540 2,000Z + 0.6XZ 4,284 + 0.6XZ2 + 2,000Z + 2,400Z2
Note that the market interest rate is a random variable as the general
inflation rate becomes a random variable. There are nine joint events for X
and Y. For a joint event where X = 10,000 and Y = 0.05 (i.e., = 1.05), we
first calculate the market interest rate and then evaluate the PE function at
this market interest rate.

15-18
i i f if
0.10 + 0.05 + (0.10)(0.05)
15.5%
PW (15.5%) $11,000 [2,540 2,000(1.05) 0.6(10,000)(1.05)]

( P /F , 15.5%, 1) [4, 284 0.6(10,000)(1.05) 2 2,000(1.05)
2, 400(1.05) 2 ]( F /P, 15.5%, 2)
$6,563
The PW(X, Y) for the remaining joint events are shown in the table below.
(b) We calculate the weighted PW of every possible event that equals p(X)
p(Y) PW(X, Y), and then sum them to give the expected Present
Equivalent (see table below).
(c) The equation and results for the variance calculation are provided in the last
column of the table below.
Annual Revenue Inflation Rate Y Weighted Weighted Deviation

PW
Value p(X) Value p(Y) i PW(i) p(X)p(Y)PW p(X)p(Y)[PW E(PW)]2
$10,000 0.30 3.0% 0.25 13.3% $6,762 $507 20,348,629
10,000 0.30 5.0 0.50 15.5 6,563 984 38,372,866
10,000 0.30 7.0 0.25 17.7 6,374 478 20,420,712
20,000 0.40 3.0 0.25 13.3 17,176 1,718 23,290,614
20,000 0.40 5.0 0.50 15.5 16,976 3,395 36,902,530
20,000 0.40 7.0 0.25 17.7 16,787 1,679 23,409,391
30,000 0.30 3.0 0.25 13.3 27,589 2,069 16,672,348
30,000 0.30 5.0 0.50 15.5 27,390 4,108 24,846,999
30,000 0.30 7.0 0.25 17.7 27,200 2,040 16,737,602
E(PW)= $16,979 var(PW) = $221,001,691
Comparing Risky Projects

15.18
E[PW ]1 ($2,000)(0.20) + ($3,000)(0.60) + ($3,500)(0.20) $1,000

$1,900
E[PW ]2 ($1,000)(0.30) + ($2,500)(0.40) + ($4,500)(0.30) $800
$1,850
Project 1 is preferred over Project 2.

15-19
(b) Var[PW ]1 (2,000 1,900) 2 (0.20) + (3,000 1,900) 2 (0.60) +

(3,500 1,900) 2 (0.20)
1,240,000
Var[PW ]2 (1,000 1,850) 2 (0.30) + (2,500 1,850) 2 (0.40)
(4,500 1,850) 2 (0.30)
2,492,500
Project 1 is still preferred because Var[PW]1 < Var[PW]2 and E[PW]1 >
[PW]2.
15.19
(a) Mean and variance calculations:
E[PW ]1 ($100,000)(0.20) + ($50,000)(0.40) + (0)(0.40)

$40,000
E[PW ]2 ($40,000)(0.30) + ($10,000)(0.40) + ( $10,000)(0.30)
$13,000
Var[PW ]1 (100,000 40,000) 2 (0.20) + (50,000 40,000) 2
(0.40) + (0 40,000) 2 (0.40)
1,400,000,000
Var[PW ]2 (40,000 13,000) 2 (0.30) + (10,000 13,000) 2 (0.40) +( 10,000 13,000) 2 (0.30)
381,000,000
It is not a clear case because El > E2 but also Var1 > Var2. If she makes her
decision based solely on the principle of maximization of expected value,
she may prefer Contract A.
(b) Assuming that both contracts are statistically independent from each other,
Joint Event Joint

(PWA > PWB) Probability
($100,000, $40,000) (0.20)(0.30) = 0.06
($100,000, $10,000) (0.20)(0.40) = 0.08
($100,000, $10,000) (0.20)(0.30) = 0.06
($50,000, $40,000) (0.40)(0.30) = 0.12
($50,000, $10,000) (0.40)(0.40) = 0.16
($50,000, $10,000) (0.40)(0.30) = 0.12
($0, $10,000) (0.40)(0.30) = 0.12
0.72

15-20
15.20
(a)
Machine A:
CR(10%) A = ($60,000 $22,000)(A / P, 10%, 6) + (0.10)($22,000)

$10,924
E[AE (10%)] A = ($5,000)(0.20) + ($8,000)(0.30) + ($10,000)(0.30) +
($12,000)(0.20) + $10,924
$19,725
Var[AE (10%)]A (15,924 19,725) 2 (0.20) + (18,924 19,725) 2 (0.30) +
(20,924 19,725) 2 (0.30) + (22,924 19,725) 2 (0.20)
5,560,000
Machine :
CR(10%) B $35,000(A / P, 10%, 4)

$11,042
E[AE (10%)]B ($8,000)(0.10) + ($10,000)(0.30) + ($12,000)(0.40) +
($14,000)(0.20) + $11,042
$22,442
Var[AE (10%)]B (19,042 22,442) 2 (0.10) + (21,042 22,442) 2 (0.30) +
(23,042 22,442) 2 (0.40) + (25,042 22,442) 2 (0.20)
3,240,000
(b) Prob[AE(10%)A > (10%)B]:
Joint Event Joint

(O&MA, O&MB) (AEA > AEB) Probability
($10,000, $8,000) ($20,924, $19,042) (0.30)(0.10) = 0.03
($12,000, $8,000) ($22,924, $19,042) (0.20)(0.10) = 0.02
($12,000, $10,000) ($22,924, $21,042) (0.20)(0.30) = 0.06
0.11
15.21
(a) Mean and variance calculation (Note: For a random variable Y, which can
be expressed as a linear function of another random variable X (say, Y = aX,
where a is a constant), the variance of Y can be calculated as a function of
variance of X, Var[Y] = a2Var[X].)

15-21
E[PW ]A $5,000 + $4,000(P /F , 15%, 1) $4,000 (P /F , 15%, 2)

$1,502.83
E[PW ]B $10,000 + $6,000(P /F , 15%, 1) + $8,000(P /F , 15%, 2)
$1,266.54
Var[PW ]A 1,0002 + (P /F , 15%, 1)21,0002 + (P /F , 15%, 2) 21,5002
3,042,588
Var[PW ]B 2,0002 + (P /F , 15%, 1) 21,5002 + (P /F , 15%, 2) 2 2,0002
7,988,336
(b) Comparing risky projects
Project A Project
E[PW] $1,503 $1,267
Var[PW] 3,042,688 7,988,336
Project A is preferred over Project B because Var[PW]A < Var[PW]B and

E[PW]A > E[PW]B.
Decision Tree Analysis

15.22
(a) Lets define the symbols:
P: Party is taking place

NP: No party is planned
TP: Tipster says P
TNP: Tipster says NP
Then
P(NP TP) P (TP) P (NP)P (TP|NP)

(0.4)(0.2) 0.08
(b)
Optimal decision without sample information:
EMV = (0.6)(100) + (0.4)(50) = 40 points
Raid the dormitories.
Joint probabilities:

15-22
P(P TP) P (P)P (TP/P) (0.60)(0.40) = 0.24

P(P TNP) P (P)P (TNP/P) (0.60)(0.60) 0.36
P(NP TP) P (NP)P (TP/NP) (0.40)(0.20) 0.08
P(NP TNP) P (NP)P (TNP/NP) (0.40)(0.80) 0.32
Marginal probabilities:
P(TP) P(P TP) + P(NP TP)

0.24 + 0.08 0.32
P(TNP) P(P TNP) + P (NP TNP)
0.36 + 0.32 0.68
State of Nature Tipster Says Marginal

NP Probability
P 0.24 0.36 0.6
Actual NP 0.08 0.32 0.4
Marginal Probability 0.32 0.68 1
Revised probabilities after receiving the tips:
P (P TP) 0.24
P(P/TP) 0.75
P (TP) 0.32
P (NP TP) 0.08
P(NP/TP) 0.25
P(TP) 0.32
P (P TNP) 0.36
P (P/TNP) 0.5294
P(TNP) 0.68
P (NP TNP) 0.32
P (NP/TNP) 0.4706
P(TNP) 0.68
Optimal decision after receiving the tips: The tipsters information has
no value, even though it costs nothing. Do not reply on the tips.

15-23
* Decision Tree
(c) EVPI = 60 40 = 20
Comments: Note that if a party is planned, raid and earn 100 points. If no
party is planned, do not raid and earn no points. The expected profit with perfect
information is
EPPI = (0.6)(100) + (0.4)(0) = 60 points
15.23
(a) Given:
Tax rate 40%
Year 1 CCA1 = (0.04/2)($500,000)
CCA Year 2 CCA2 = 0.04($490,000)

Year 15 CCA15 = 0.04($288,219)
UCC15 $276,690
Salvage Value $100,000
Net proceeds from sale (S + G) $170,676

15-24
Case 1: With high demand,
PW (15%) $500,000 + 0.6($1,000,000)(P /A, 15%, 15)

+ 0.4($10,000)(P /F , 15%, 1) + ...
+0.4($11,529) (P /F , 15%, 15) $170,676(P /F , 15%, 15)
$3,065,893
Case 2: With medium demand, PW(15%) = $1,311,682

Case 3: With lower demand, PW(15%) = $723,203
EMVopen (0.3)($3,065,893) + (0.4)($1,311,682) + (0.3)( $723,203)

$1,227,480
EMVdo not open = 0

Open the store.
EVPI = EPPI EMV = $216,961
EPPI (0.3)($3,065,893) + (0.4)(1,311,682) + (0.3)(0)

$1,444,441
(b) Investment decision with sample information. Lets define the symbols.
= High demand
= Medium demand
L = Low demand
SH = Survey predicts a H demand.
SM = Survey predicts an M demand.
SL = Survey predicts a L demand.
Joint/marginal probabilities:
P(H SH) P (H)P (SH/H) (0.30)(0.70) 0.21

P(H SM) P(H)P(SM/H) (0.30)(0.25) 0.075
P(H SL) P (H)P (SL/H) (0.30)(0.05) 0.015

P(L SL) P (L)P (SL/L) (0.30)(0.75) 0.225

15-25
Marginal probabilities:
P(SH) P(H SH) + P(M SH) + P(L SH)

0.24 + 0.08 + 0.15 0.305
P (SM) 0.075 + 0.24 + 0.06 0.375
P(SL) 0.015 + 0.08 + 0.215 0.320
State of Nature Survey Says Marginal

High Medium Low Probability
High 0.21 0.075 0.015 0.3
Actual Medium 0.08 0.24 0.08 0.4
Low 0.015 0.06 0.225 0.3
Marginal Probability 0.305 0.375 0.320 1
Revised probabilities after seeing the survey results:
P(H SH) 0.21

P(H/SH) 0.6885
P(SH) 0.305
P(M SH) 0.08
P (M/SH) 0.2623
P(SH) 0.305

P(L SL) 0.225
P(L/SL) 0.7031
P(SL) 0.320
Optimal decision: Take a survey. With either High or Low result

from the survey, open the store. Otherwise, do not open the store.
The expected monetary value after taking the survey is $1,238,252.

15-26
*Decision Tree (Problem 15.23)

15-27
Short Case Studies

ST15.1 Discussion: In Virginia, one investment group came tantalizingly close to
cornering the market on all possible combinations of six numbers from 1
to 44. State lottery officials say that the group bought 5 million of the
possible 7 million tickets (precisely 7,059,052). Each ticket cost $1 each.
The lottery had a more than $27 million jackpot.
44!
C (44, 6) 7, 059, 052
6!(44 6)!
Economic Logic: If the jackpot is big enough, provided nobody else

buys a winning ticket, it makes economic sense to buy one lottery ticket
for every possible combination of numbers and be sure to win. A group
in Australia apparently tried to do this in the February 15 (1992)
Virginia Lottery drawing.
The Cost: Since 7,059,052 combinations of numbers are possible3 and

each ticket costs $1, it would cost $7,059,052 to cover every
combination. The total remains the same regardless of the size of the
jackpot.
The Risk: The first prize jackpot is paid out in 20 equal yearly
installments, so the actual payoff on all prizes is $2,261,565 the first
year and $1,350,368 per year for the next 19 years. If more than one
first prize-winning ticket is sold, the prize is shared so that the
maximum payoff depends on an ordinary player not buying a winning
ticket. Since Virginia began its lottery in January 1990, 120 of the 170
drawings have not yielded a first-prize winner.
Solution
In the Virginia game, 7,059,052 combinations of numbers are possible.

The following table summarizes the winning odds for various prizes for a
one ticket-only purchase.
Number of Prizes Prize Category Winning Odds

1 First prize 0.0000001416
228 Second prizes 0.0000323
10,552 Third prizes 0.00149
168,073 Fourth prizes 0.02381
So a person who buys one ticket has odds of 1 in slightly more than 7
million. Holding more tickets increases the odds of winning, so that 1,000
tickets have odds of 1 in 7,000 and 1 million tickets have odds of 1 in 7.
Since each ticket costs $1, it would receive at least a share in the jackpot

15-28
and many of the second, third, and fourth place prizes. Together these
combined prizes (second through fourth) were worth $911,197 payable in
one lump sum. Suppose that the Australia group bought all the tickets
(7,059,052). We may consider two separate cases.
Case 1: If none of the prizes were shared, the rate of return on this
lottery investment, with prizes paid at the end of each year, would be
PW (i ) $7,059,052 + $911,197 (P/F, i, 1)

+$1,350,368(P/A, i, 20)
0
i* 20.94%
The first-prize payoff over 20 years is equivalent to putting the same

$7,059,052 in a more conventional investment that pays a guaranteed
20.94% return before taxes for 20 years, a rate available only from
speculative investments with fairly high risk. (If the prizes are paid at
the beginning of each year, the rate of return would be 27.88 %.)
Case 2: If the first prize is shared with one other ticket, the rate of return
on this lottery investment would be 8.87%. (With the prizes paid at the
beginning of each year, the rate of return would be 10.48%.) Certainly,
if the first prize is shared by more than one, the rate of return would be
far less than 8.87%.
ST15.2 Since the amount of annual labour savings is the same for alternatives, this
labour savings factor is not considered in the following analysis.
(a) After-tax cash flows:
After-Tax Cash Flows

n Lectra System Tex System
0 ($136,150) ($195,500)
1 115,204 145,165
2 120,922 153,376
3 116,756 147,393
4 113,839 143,206
5 111,798 140,274
6 130,149 158,394
PW(12%) 347,935 412,146
AE(12%) 84,627 100,244
Based on the most-likely estimates, the Tex system is the better choice.
(b) Let X and Y denote the annual material savings for the Lectra system and

15-29
Tex system, respectively.
After-Tax Cash Flows

n Lectra System Tex System
0 $136,150 $195,500
1 0.6X 22,796 0.6Y 19,235
2 0.6X 17,078 0.6Y 11,024
3 0.6X 21,244 0.6Y 17,007
4 0.6X 24,161 0.6Y 21,194
5 0.6X 26,202 0.6Y 24,126
6 0.6X 7,851 0.6Y 6,006
Lectra System:
AE (12%) Lectra $53,373 + 0.6X

E[X ] $224,000
Var[X ] = 899,000,000
E[AE (12%)]Lectra $53,373 + 0.6E[X ]
$81,027
Var[AE (12%)]Lectra (0.6) 2Var[X ]
323,640,000
Tex System:
AE (12%)Tex $64,156 + 0.6Y

E[Y ] $259,400
Var[Y] 1,718,440,000
E[AE (12%)]Tex $64,156 + 0.6E[Y ]
$91,484
Var[AE (12%)]Tex (0.6) 2Var[Y ]
618,638,400
(c) Probabilistic analysis:
Variable Savings Probability AE(12%)

$150,000 0.25 $36,627
X 230,000 0.40 84,627
270,000 0.35 108,627
200,000 0.30 55,844
Y 274,000 0.50 100,244
312,000 0.20 123,044
Joint Event Joint

15-30
(X, Y) (AELectra>AETex) Probability

(230,000, 200,000) ($84,627, $55,844) (0.40)(0.30) = 0.120
(270,000, 200,000) ($108,627, $55,844) (0.35)(0.30) = 0.105
(270,000, 274,000) ($108,627, $100,244) (0.35)(0.50) = 0.175
0.400
ST15.3 (a) Project cash flows:
Year 0 1 2 3 4 5 6 7 8-19 20
Income Statement
Revenues:
Steam sales 1,550,520 1,550,520 1,550,520 1,550,520 1,550,520 1,550,520 1,550,520 1,550,520 1,550,520
Tipping fee 976,114 895,723 800,275 687,153 553,301 395,161 208,585
Expenses:
O&M costs 832,000 832,000 832,000 832,000 832,000 832,000 832,000 832,000 832,000
Interest (11.5%) 805,000 805,000 805,000 805,000 805,000 805,000 805,000 805,000 805,000
Taxable income 889,634 809,243 713,795 600,673 466,821 308,681 122,105 (86,480) (86,480)
Income taxes (0%)
Net income 889,634 809,243 713,795 600,673 466,821 308,681 122,105 (86,480) (86,480)
Cash Flow
Statement
Cash from
operations:
Net income 889,634 809,243 713,795 600,673 466,821 308,681 122,105 (86,480) (86,480)
Investment/salvage:
Equipment (6,688,800) 300,000
Financing:
Loan payment 6,688,800 (7,000,000)
Net cash flow 0 889,634 809,243 713,795 600,673 466,821 308,681 122,105 (86,480) (6,786,480)
PW(10%) = $1,639,723
(b) Let X denote the steam charge per tonne. Then
annual steam charge = 1,061,962(X)(365)/1,000 = 387,616X
n Revenue Expenses
1 $387,616X $660,886
2 $387,616X $741,277
3 $387,616X $836,725
4 $387,616X $949,847
5 $387,616X $1,083,699
6 $387,616X $1,241,830
7 $387,616X $1,428,415
819 $387,616X $1,637,000
20 $387,616X $8,337,000

15-31
AE (10%) $387,616X [$660,886(P / F , 10%,1) ...

$8,337,000(P /F , 10%, 20)](A / P, 10%, 20)
$387,616X $1,357,918
0
X $3.503 per tonne
(c) Sensitivity graph
ST15.4
(a) Project cash flows based on most likely estimates:
MARR = 0.18 t = 0.38 d = 0.3 n = 8

Year 0 1 2 3 4 5 6 7 8
Income Statement
Revenue (Savings):
Telephone bill 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000
Deadhead kilometres 1,250 1,250 1,250 1,250 1,250 1,250 1,250 1,250
Expenses:
CCA 1,500 2,550 1,785 1,250 875 612 429 300
Taxable income 2,750 1,700 2,465 3,001 3,375 3,638 3,821 3,950
Income tax 1,045 646 937 1,140 1,283 1,382 1,452 1,501
Net income 1,705 1,054 1,528 1,860 2,093 2,255 2,369 2,449
Cash Flow Statement
Net income 1,705 1,054 1,528 1,860 2,093 2,255 2,369 2,449
CCA 1,500 2,550 1,785 1,250 875 612 429 300
Investment (10,000)
Salvage 0
Disposal tax effect 266

15-32
Net cash flow (10,000) 3,205 3,604 3,313 3,110 3,967 2,868 2,798 3,015
PW(18%) = $2,965
AE(18%) = $727
IRR = 0.2749
(b) Sensitivity analysis:
Percentage Savings Savings

Deviation in T.B. PW(18%) in DM PW(18%)
30.00% $2,100,000 $689,000 $875,000 $2,017,000
20.00 2,400,000 1,448,000 1,000,000 2,333,000
10.00 2,700,000 2,206,000 1,125,000 2,649,000
0.00 3,000,000 2,965,000 1,250,000 2,965,000
10.00 3,300,000 3,723,000 1,375,000 3,281,000
20.00 3,600,000 4,482,000 1,500,000 3,597,000
30.00 3,900,000 5,240,000 1,625,000 3,913,000
(c) Sensitivity graph:

15-33
ST15.5
(a) Incremental project cash flows (FMS CMT):
Income Statement (FMS CMT)
0 1 2 3 4 5
Revenues:
Savings in VLC $462,400 $462,400 $462,400 $462,400 $462,400
Savings in VMC 233,920 233,920 233,920 233,920 233,920
Savings in AOC 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000
Savings in ATC 170,000 170,000 170,000 170,000 170,000
Savings in AIC 109,500 109,500 109,500 109,500 109,500
Expenses:
Equipment in CCA 975,000 1,657,500 1,160,250 812,175 568,523
Taxable income 1,200,820 518,320 1,015,570 1,363,645 1,607,298
Income taxes (40%) 480,328 207,328 406,228 545,458 642,919
Net income $720,492 $310,992 $609,342 $818,187 $964,379
Cash Flow Statement
Cash flow operation:
Net income $720,492 $310,992 $609,342 $818,187 $964,379
CCA 975,000 1,657,500 1,160,250 812,175 568,523
Equipment ($6,500,000)
Disposal tax effect
Net cash flow ($6,500,000) $1,695,492 $1,968,492 $1,769,582 $1,630,362 $1,532,901
n 6 7 8 9 10
Revenues:
Savings in VLC $462,400 $462,400 $462,400 $462,400 $462,400
Savings in VMC 233,920 233,920 233,920 233,920 233,920
Savings in AOC 1,200,000 1,200,000 1,200,000 1,200,000 1,200,000
Savings in ATC 170,000 170,000 170,000 170,000 170,000
Savings in AIC 109,500 109,500 109,500 109,500 109,500
Expenses:
Equipment in CCA 397,966 278,576 195,003 136,502 95,552
Taxable income 1,777,854 1,897,244 1,980,817 2,039,318 2,080,268
Income taxes (40%) 711,142 758,898 792,327 815,727 832,107
Net income $1,066,713 $1,138,346 $1,188,490 $1,223,591 $1,248,161
Cash Flow Statement
Cash flow operation:
Net income $1,066,713 $1,138,346 $1,188,490 $1,223,591 $1,248,161
CCA 397,966 278,576 195,003 136,502 95,552
Equipment 500,000
Disposal tax effect ($110,819)
Net cash flow $1,464,678 $1,416,922 $1,383,493 $1,360,093 $1,732,894
W (15%) = $1,753,756

15-34
(b) and (c) Sensitivity analysis:
(d) Best and worse scenarios:
Best case: Material cost = $1.00 per part, annual inventory cost =
$25,000
PW(15%)FMS CMT = $1,937,141
Worst case: Material cost = $1.40 per part, annual inventory cost =
$100,000
PW(15%)FMS CMT = $1,056,046
(e) Mean and variance analysis:

E[PW(15%)FMS CMT]:
Calculation of the mean of PE Distribution
Event Joint Weighted

No. VMC Prob. AIC Prob. Prob. PW(15%) PW
1 1.0 0.25 25,000 0.1 0.025 1,937,145 48,429
2 1.1 0.3 25,000 0.1 0.03 1,773,332 53,200
3 1.2 0.2 25,000 0.1 0.02 1,609,520 32,190
4 1.3 0.2 25,000 0.1 0.02 1,445,707 28,914
5 1.4 0.05 25,000 0.1 0.005 1,281,894 6,409
6 1.0 0.25 31,000 0.3 0.075 1,919,077 143,931
7 1.1 0.3 31,000 0.3 0.09 1,755,265 157,974
8 1.2 0.2 31,000 0.3 0.06 1,591,452 95,487
9 1.3 0.2 31,000 0.3 0.06 1,427,639 85,658
10 1.4 0.05 31,000 0.3 0.015 1,263,827 18,957
11 1.0 0.25 50,000 0.2 0.05 1,861,863 93,093

15-35
12 1.1 0.3 50,000 0.2 0.06 1,698,051 101,883

13 1.2 0.2 50,000 0.2 0.04 1,534,238 61,370
14 1.3 0.2 50,000 0.2 0.04 1,370,425 54,817
15 1.4 0.05 50,000 0.2 0.01 1,206,613 12,066
16 1.0 0.25 80,000 0.2 0.05 1,771,526 88,576
17 1.1 0.3 80,000 0.2 0.06 1,607,713 96,463
18 1.2 0.2 80,000 0.2 0.04 1,443,900 57,756
19 1.3 0.2 80,000 0.2 0.04 1,280,088 51,204
20 1.4 0.05 80,000 0.2 0.01 1,116,275 11,163
21 1.0 0.25 100,000 0.2 0.05 1,711,300 85,565
22 1.1 0.3 100,000 0.2 0.06 1,547,488 92,849
23 1.2 0.2 100,000 0.2 0.04 1,383,675 55,347
24 1.3 0.2 100,000 0.2 0.04 1,219,862 48,794
25 1.4 0.05 100,000 0.2 0.01 1,056,050 10,561
E[PW] = 1,592,657
Var[PW(15%) FMS CMT]:
Calculation of the variance of PW Distribution
E[PW] = 1,592,657
Event Joint Weighted PW(PW )2

No. VMC Prob. AIC Prob. Prob. PW (15%)
1 1.0 0.25 25,000 0.1 0.025 1,937,145 2,966,799,554
2 1.1 0.3 25,000 0.1 0.03 1,773,332 979,303,669
3 1.2 0.2 25,000 0.1 0.02 1,609,520 5,687,215
4 1.3 0.2 25,000 0.1 0.02 1,445,707 431,886,050
5 1.4 0.05 25,000 0.1 0.005 1,281,894 482,868,210
6 1.0 0.25 31,000 0.3 0.075 1,919,077 7,991,251,230
7 1.1 0.3 31,000 0.3 0.09 1,755,265 2,379,722,550
8 1.2 0.2 31,000 0.3 0.06 1,591,452 87,121
9 1.3 0.2 31,000 0.3 0.06 1,427,639 1,633,856,419
10 1.4 0.05 31,000 0.3 0.015 1,263,827 1,621,937,534
11 1.0 0.25 50,000 0.2 0.05 1,861,863 3,623,593,522
12 1.1 0.3 50,000 0.2 0.06 1,698,051 666,473,714
13 1.2 0.2 50,000 0.2 0.04 1,534,238 136,511,182
14 1.3 0.2 50,000 0.2 0.04 1,370,425 1,975,482,473
15 1.4 0.05 50,000 0.2 0.01 1,206,613 1,490,299,699
16 1.0 0.25 80,000 0.2 0.05 1,771,526 1,599,705,958
17 1.1 0.3 80,000 0.2 0.06 1,607,713 13,600,988
18 1.2 0.2 80,000 0.2 0.04 1,443,900 885,145,802
19 1.3 0.2 80,000 0.2 0.04 1,280,088 3,907,975,190
20 1.4 0.05 80,000 0.2 0.01 1,116,275 2,269,398,099
21 1.0 0.25 100,000 0.2 0.05 1,711,300 703,808,072
22 1.1 0.3 100,000 0.2 0.06 1,547,488 122,414,314

15-36
23 1.2 0.2 100,000 0.2 0.04 1,383,675 1,746,939,053

24 1.3 0.2 100,000 0.2 0.04 1,219,862 5,559,044,481
25 1.4 0.05 100,000 0.2 0.01 1,056,050 2,879,470,724
V[PW] = 46,073,262,826
SS[PW] = 214,647
(f) In no situation would the FMS be a more expensive instrument option

than the CMT.

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15-1

Chapter 15 Project Risk and Uncertainty

total CCA $60,218

After-tax Net Cash Flow

The project is acceptable in either situation.

(c) Required annual savings (X):

$85,000 (0.6X)(P /A, 20%, 4) + $5,100(P /F , 20%, 1) +

Let X denote the additional after-tax annual cash flow:

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

PW (28.65%) $500, 000 X ( P /A, 28.65%, 4)( P /F , 28.65%, 1) 0

Net Cash Flows

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

29 162,323 (77,967) (319,674) (221,261) 2

Net Present Worth

UCC0 = $40,000(1 0.15)(1 0.30)3 = $11,662

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Incremental cash flows:

The defender should be retained.

PWD + (1 t)X = PWC

So if the current sale price were $6,000 $2,752 = $8,752, we would be

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

cost per metre $5.55

Option 2: Fibre optics:

1 repeater, 21 modulators in central office, 21 modulators in field

ribbon cost $74,568

Option 1 is the better choice since PW1 > PW2.

(b) Either 16 km or 40 km of transmission distance:

Option 2 is the better choice by a slight margin.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Option 2 is the better choice.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Model A is a better choice since it is cheaper.

PW (10%) A $6,000 + ($270 0.7X)(P /F , 10%, 1) + ... +

Let (10%) = AE(10%)B, and solve for X.

$850 0.7X $1,405

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

(c) With a shorter service life:

Net Cash Flow

Model A is still preferred over Model B.

15.7 (a) and (b):

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

15.8 Sensitivity graph:

P0 = $2,200,000 $600,000 $400,000 = $3,200,000

P1 $4,000(365)X (1 0.31)(P /A, 10%, 25)

PW of after-tax operating costs:

P2 ($230,000 + $170,000X )(1 0.31)(P/A, 10%, 25)

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

PW of tax savings due to capital cost allowance:

CCA on CCA on CCA Tax Savings

P3 $26,040(P / F , 10%, 1) + $49,054(P / F , 10%, 2) + ... +

PW of net proceeds from sale of capital assets:

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.

net proceeds from sale $527 + $250,911 + $1,698,354

15.10 Useful life of the old bulb: 13,870/(19 365) = 2 years

PW (15%)old (1 0.40) $61.90 [1 (P /F , 15%, 2)]

The break-even price for the new bulb will be

0.6X 9.6 $65.23

P1 X (1 0.30)(P / A, 15%, 20)

PW of after-tax operating costs:

PW of the investment and tax effects:

n CCABuilding Tax Savings (30%)

Copyright 2012 Pearson Canada Inc., Toronto, Ontario.