Question

3. Gregg wants to analyze the risk of the project using sensitivity analysis and Monte Carlo simulation. a. Explain to Baldwin Inc. how the two risk analysis models can be used to analyze risk of the project.

4. Gregg has estimated the fixed costs (including depreciation) of the Ohio project to be $1.5 million, sales price is $130, and the variable cost is $70, giving a contribution margin of $60. What is the break-even quantity for this project?

5. Baldwin Inc. wants to know the likely effect of the capital budgeting decision on its stock price (increase, decrease, no change, or not sure). Choose one and explain why.

Answer 1

3. sensitivity analysis - with sensitivity analysis, Gregg can analyze the project risk easily, by noticing the behavior change in the variables. In the sensitivity analysis, there is a change in behavior of the critical variables which have a serious impact on the profitability of the project. Moreover, In the monte Carlo simulation, It provides all possible outcomes of a project. It creates risk assessment of every possible outcome. in this, the results are compared against risk tolerance. So it will help Gregg to analyze the risk of the project.

4. Break-even Quantity: Formula for break-even in units is = Fixed cost / (Sales Price per unit - variable cost per unit).

FC = $1.5 million, sales Price = $130 per unit, Variable cost = $70 per unit.

=> 1500000/(130-70)

=> 25000 units.

5. the effect of the capital budgeting on the stock price is very much positive. it would likely increase the value of the company. Capital Budgeting decision is based on the NPV and IRR of the project. It also helps in the risk assessment of the project. It enhances the decision of the investor which he will take with the help of capital budgeting. So with the help of this, he will take a wise decision for the company which will increase the performance of the company thus attracting the investor more and increasing the stock prices of the firm.