Risk analysis and management.

1. Comment on the following statements: a. “Because our new expansion project has the same systematic risk as the firm as a whole, we need do no further risk analysis on the project.” b. «Our company should accept the new potash mine project at Moosejaw. The cost of additional loans to fund the project is 12%, and our simulations lead us to expect a 14% return from the project.” c. “It is difficult to decide whether to spend $10 million to reopen our mine because the price of gold is so uncertain. However, if we assume the price of gold grows at an average of 5% a year with a standard deviation of 20% a year, simulation indicates the mine has an average NPV of $500,000. Therefore, we should reopen. 2. What is the advantage of using certainty-equivalent cash flows instead of risk-adjusted discount rates to calculate the NPV of an investment project 3. In early 1990, Boeing Co. decided to gamble $4 billion to build a new long-distance, 350-seat wide-body airplane called the Boeing 777. The price tag for the 777, scheduled for delivery beginning in 1995, is about $120 million apiece. Assume that Boeing’s $4 billion investment is made at the rate of $800 million a year for the years 1990 through 1994 and that the present value of the tax write-off associated with these costs is $750 million. Based on estimated annual fixed costs of $100 million, variable production costs of $90 million apiece, a marginal corporate tax rate of 34% and a discount rate of 14%, what is the break-even quantity of annual unit sales over the Boeing 777’s projected 15-year life? Assume that all cash inflows and outflows occur at the end of the year 4. The recently opened Grand Hyatt Wailea Resort and Spa on Maui cost $600 mill about $800,000 per room, to build. Daily operating expenses average $135 a room if occupied and $80 a room if unoccupied (much of the labor cost of running a hotel is fixed) at an average room rate of $500 a night. A marginal tax of 40%, and a cost of capital of 11%, what year round occupancy rate do the Japanese investors who financed the Grand Hyatt Wailea require to break even in economic terms on their investment over its estimated 40 yr. life? What is the likelihood that this investment will have a positive NPV? Assume that the $450 million expense of building the hotel can be written off straight line over a 30 year period (the other$150 million is for the land which is not depreciable) and that the present value of the hotels terminal value will be $200 million.

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