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Chapter 18
Sensitivity Analysis and Staged Decisions
18.1 $135,000: PW = -500,000 + 135,000(P/A,15%,5)
= -500,000 + 135,000(3.3522)
= $-47,453 (ROR < 15%)
$165,000: PW = -500,000 + 165,000(P/A,15%,5)
= -500,000 + 165,000(3.3522)
= $53,113
(ROR > 15%)
The decision to invest is sensitive to the revenue estimates
18.2 Start family now: FW = 50,000(F/A,10%, 5)(F/P,10%,20) + 15,000(F/A,10%,20)
= 50,000(6.1051)(6.7275) + 15,000(57.2750)
= $2,912,728
( > $2,600,000)
Their retirement goal is not sensitive to when they start their family.
18.3 Invest now:
FW = -80,000(F/P,20%,6) + 25,000(F/A,20%,6)
= -80,000(2.9860) + 25,000(9.9299)
= $9368
( > 20% per year)
Low pressure:
18.5
AWcurrent = $-63,000
AW10,000 = -64,000(A/P,15%,3) 38,000 + 10,000(A/F,15%,3)
= -64,000(0.43798) 38,000 + 10,000(0.28798)
= $-63,151
AW13,000 = -64,000(A/P,15%,3) 38,000 + 13,000(A/F,15%,3)
= -64,000(0.43798) 38,000 + 13,000(0.28798)
= $-62,287
AW18,000 = -64,000(A/P,15%,3) 38,000 + 18,000(A/F,15%,3)
= -64,000(0.43798) 38,000 + 18,000(0.28798)
= $-60,847
The decision is sensitive to the salvage value estimates. If the salvage value will be
$13,000 or $18,000, the company should replace the existing machine. Otherwise, keep
the current one.
18.6
Joe:
Jane:
AWCnt = $-175,000
AWHigh = -250,000(A/P,15%,3) -75,000 + 90,000(A/F,15%,3)
= -250,000(0.43798) -75,000 + 90,000(0.28798)
= $-158,577 (< $-175,000)
AWLow = -250,000(A/P,15%,3) -75,000 + 10,000(A/F,15%,3)
= -250,000(0.43798) -75,000 + 10,000(0.28798)
= $-181,615 (> $-175,000)
Decision is sensitive to salvage value.
18.8
18.9
QBE, units
6667
8333
10,000
11,667
13,333
(b) The change in QBE is 1667 units for each $50,000 increase in FC.
18.11
PW = P + (60,000 5000)(P/A,10%,5)
= P + 55,000(3.7908)
= P + 208,494
Percent
variation
-25%
-20
-10
0
10
20
25
18.12
P value, $
-150,000
-160,000
-180,000
-200,000
220,000
240,000
250,000
18.13
PW, $
58,494
48,494
28,494
8,494
-11,506
-31,506
-41,506
R value, $
45,000
48,000
54,000
60,000
66,000
72,000
75,000
PW, $
-48,368
-36,996
-14,251
8,494
31,239
53,984
65,356
n value
4.0
4.5
5.0
5.5
6.0
6.5
7.0
PW, $
-25,656
-8,175
8,494
24,386
39,541
46,849
67,762
18.14 Spreadsheet is plotted for all three parameters: P. R and n. Variations in P and R have
about the same effect on PW in opposite directions, and more effect than variation in n.
18.15 Set up the F relation in 20 years, consider this a P value, and calculate the withdrawals at
A = P(i) forever. Let A = annual deposit and R = annual withdrawal after year 20
Future worth of deposits: F = A(F/A,i,n) = 27,185(F/A,6%,20)
= 27,185(36.7856)
= $1,000,016
Withdrawals: R = F(i) = 1,000,016(0.06)
= $60,000 per year forever
Hand solution
(a)
R = A(F/A,6%,20)(i) = A(36.7856)(0.06)
Percent
variation
-5%
0
5%
A, annual
deposit, $
25,826
27,185
28,544
R,
$ per year
57,000
60,000
63,000
(b) R = 27,185(F/A,i,20)(i)
Return Percent
R,
value variation $ per year
5%
-16.7% 44,945
6%
0
60,000
7%
16.7% 78,012
The amount available for annual withdrawal is much more sensitive to i than to A.
Spreadsheet solution
18.16 Spreadsheet for -20% to +20% changes in P, AOC, R, n and MARR follows. The PMT
function for a +20% change is detailed at the bottom of the spreadsheet.
AW is most sensitive to variations in revenue R and least sensitive to variations in life n.
18.18 (a) PW calculates the amount you should be willing to pay now. Plot PW versus + 30%
changes in (a), (b) and (c) on one graph.
(1) Face value, V
PW = V(P/F,4%,20) + 450(P/A,4%,20)
= V(0.4564) + 6116
(2) Dividend rate, b
PW = 10,000(P/F,4%,20) + (10,000/2)(b)(P/A,4%,20)
= 10,000(0.4564) + b(5000)(13.5903)
= 4564 + b(67,952)
(3) Nominal rate, r
PW = 10,000(P/F,r,20) + 450(P/A,r,20)
AWContract = $-190,000
AWOptimistic = -240,000(A/P,20%,5) - 60,000 + 30,000(A/F,20%,5)
= -240,000(0.33438) - 60,000 + 30,000(0.13438)
= $-136,220
( < $-190,000; purchase equipment)
AWMost Likely = -240,000(A/P,20%,5) - 85,000 + 30,000(A/F,20%,5)
= -240,000(0.33438) - 85,000 + 30,000(0.13438)
= $-161,220
( < $-190,000; purchase equipment)
AWPessimistic = -240,000(A/P,20%,5) - 120,000 + 30,000(A/F,20%,5)
= -240,000(0.33438) - 120,000 + 30,000(0.13438)
= $-196,220
( > $-190,000; do not purchase equipment)
The optimistic and most likely estimates favor purchasing the equipment, but the
pessimistic estimate does not.
18.20
18.21
18.22
(a)
MARR = 8% (Pessimistic)
PWM = 100,000 + 15,000(P/A,8%,20)
= 100,000 + 15,000(9.8181)
= $47,272
PWQ = 110,000 + 19,000(P/A,8%,20)
= 110,000 + 19,000(9.8181)
= $76,544
10
PWQ = $51,758
11
18.28
12
13
14
18.36
(maximum)
15
(maximum)
16
18.38 Select the minimum E(cost) alternative. All monetary units are times $-1000.
Make:
Buy:
Contract:
Select the contract alternative since the E(cost of delivery) is the lowest at $312,500.
17
18
(c)
= 100,000(P/A,15%,2) + 86,960(P/F,15%,2)
= $228,320
18.40
The return would increase on the initial investment, but would increase faster for
the produce option.
In $ billion units,
PWoption = 3 - 3.1(P/F,12%,1)
= 3 - 3.1(0.8929)
= $0.232
($232 million)
19
($6.732 million)
If the test is not successful, that is, revenue does not exceed $900,000, PW < 0.
Conclusion: Company should implement the test program option and delay the full-scale
decision for 1 year.
18.42 PWNow = -1,800,000 + 1,000,000(0.75)(P/A,15%,5)
= -1,800,000 + 1,000,000(0.75)(3.3522)
= $714,150
PW1 year = -150,000 1,900,000(P/F,15%,1) + 1,000,000(0.70)(P/A,15%,5)(P/F,15%,1)
= -150,000 1,900,000(0.8696) + 1,000,000(0.70)(3.3522)(0.8696)
= $238,311
The company should license the process now
18.43 (a) Find E(PW) after determining E(Rt), the expected repair costs for each year t
E(R2) = 1/3(-500 -1000 -0) = $-500
E(R3) = 1/3(-1200 -1400 -500) = $-1033
E(R4) = 1/3(-850 -400 -2000) = $-1083
E(PW) = -500(P/F,5%,2) -1033(P/F,5%,3) -1083(P/F,5%,4)
= -500(0.9070) -1033(0.8638) - 1083(0.8227)
= $-2237
Not considering any noneconomic factors, the warranty is worth an expected $2237, or
$263 less than the option price.
(b) PWbase = -500(P/F,5%,3) -2000(P/F,5%,4)
= -500(0.8638) -2000(0.8227)
= $-2077
18.44 Answer is (b)
18.45 Answer is (a)
18.46 Answer is (c)
20
21
2. Sensitivity to changes in life is performed by hand. Not very sensitive; plan A has the best
PW for all life estimates.
Expanding economy
nA = 40(0.80) = 32 years
n1 = 40(0.80) = 32 years
n2 = 20(0.80) = 16 years
PWA = 10,000 + 1000(P/F,10%,32) 500(P/A,10%,32)
= 10,000 + 1,000(0.0474) 500(9.5264)
= $14,716
PWB = 30,000 + 5000(P/F,10%,32) 100(P/A,10%,32) 5000
200(P/F,10%,16) 5000(P/F,10%,16) 200(P/F,10%,32)
200(P/A,10%,32)
= 35,000 + 4800(P/F,10%,32) 300(P/A,10%,32) 5200(P/F,10%,16)
= 35,000 + 4800(0.0474) 300(9.5264) 5200(0.2176)
= $38,762
22
Expected economy
23
3. Use Goal Seek to find the breakeven values of P A for the three MARR values of 4%, 7%, and
10% per year.
For MARR = 4%, the Goal Seek screen is below. Breakeven values are:
MARR
4%
7
10
Breakeven P A _
$32,623
33,424
33,734
The P A breakeven value is not sensitive, but all three outcomes are over 3X the $10,000
estimated first cost for plan A.
24
Ability to
Supply Area
1A
3
4
8
12
5(0.2)
5(0.2)
4(0.2)
1(0.2)
5(0.2)
Relative Engineering
Cost
Feasibility
4(0.2)
4(0.2)
4(0.2)
2(0.2)
5(0.2)
3(0.15)
4(0.15)
3(0.15)
1(0.15)
4(0.15)
Institutional
Issues
Environmental
Considerations
4(0.15)
3(0.15)
3(0.15)
1(0.15)
1(0.15)
5(0.15)
4(0.15)
4(0.15)
3(0.15)
3(0.15)
Lead-Time
Requirement
3(0.15)
3(0.15)
3(0.15)
4(0.15)
1(0.15)
Total
4.1
3.9
3.6
2.0
3.4
Alternative
1A
Estimate
Pessimistic
Most likely
Optimistic
Pessimistic
Most likely
Optimistic
Pessimistic
Most likely
Optimistic
M&O,
$/year
1,071,023
1,060,419
1,049,815
910,475
867,119
867,119
1,084,718
1,063,449
957,104
Number of
households
4980
5080
5230
4980
5080
5230
4980
5080
5230
Total
annual
cost, $/year
3,963,563
3,952,959
3,942,355
3,925,235
3,881,879
3,881,879
4,038,368
4,017,099
3,910,754
Household
cost,
$/month
69.82
68.25
66.12
69.40
67.03
65.10
71.13
69.37
65.59
26