PROJECT RISK ANALYSIS— COMPREHENSIVE Bridgeway Pharmaceuticals manufactures and sells ge

counter medications in plants located throughout the Western Hemisphere. One of its plants is try
to automate a portion of its packaging process by purchasing an automated waste disposal and rec
proposed investment is $400,000 to purchase the necessary equipment and get it into place. The m
five-year anticipated life and will be depreciated at a rate of $80,000 per year, toward a zero anticip
The firm’s analysts estimate that the purchase of the new waste-handling system will bring annual
$40,000 from reduced labor costs, $18,000 per year from reduced waste disposal costs, and $200,0
sale of reclaimed plastic waste net of selling expenses. Bridgeway requires a 20% return from capit
faces a 35% tax rate.
a. Using the estimates provided above, should Bridgeway purchase the new automated waste-hand
b. The manager at the plant where the handling system is being contemplated has raised some que
potential savings from the system. He asked the financial analyst in charge of preparing the propos
impact of variations in the price of plastic waste materials, which have proven to be volatile in the
what would be the impact of price reductions for the waste that drive the revenues from the sale o
their estimated amounts in Years 1 through 5?
c. (Simulation) Model the new investment, whose value is determined by the following random var
revenues from reclaimed waste in Year 1 follow a triangular distribution with a minimum value of $
likely value of $200,000, and a maximum value of $300,000.

In Year 2 (and each year thereafter), the distribution is still triangular; however, the most likely valu
value observed in the previous year. The minimum value is equal to 50% of the observed value in t
the maximum is equal to 150% of the observed value in the previous year. Furthermore, the reven
waste exhibit a correlation coefficient from year to year of .90. Labor cost savings can be forecast w
certainty, because they represent the savings from one hourly worker that will no longer be neede
waste-handling system has been put into place. The reductions in waste disposal costs come from
distribution, with minimum value of $15,000 and maximum value of $21,000.The waste disposal co
be uncorrelated over time. i. What is the probability of a cash flow less than $150,000 in Year 1? In
(Hint: Define the annual Project FCFs for Years 1 through 5 as forecast variables. You will use only th
flow distributions for this question but will use all of them to answer part iii.)

ii. What are the expected NPV and IRR for the project?
iii. (Optional) What are the means and standard deviations of the simulated distribution of cash flo
through 5? What is the effect of the positive correlation in the underlying determinants of the proj
(Hint: Look at the standard deviations in annual cash flows through time.)
cals manufactures and sells generic over-the-
sphere. One of its plants is trying to decide whether
omated waste disposal and recycling machine. The
ent and get it into place. The machine will have a
per year, toward a zero anticipated salvage value.
dling system will bring annual cost savings of
aste disposal costs, and $200,000 per year from the
quires a 20% return from capital investments and

he new automated waste-handling system?

emplated has raised some questions regarding the
harge of preparing the proposal to evaluate the
e proven to be volatile in the past. Specifically,
e the revenues from the sale of waste down to half

d by the following random variables: Annual

tion with a minimum value of $100,000, a most

; however, the most likely value is now equal to the

50% of the observed value in the previous year, and
year. Furthermore, the revenues from reclaimed
cost savings can be forecast with a high degree of
r that will no longer be needed once the new
ste disposal costs come from a uniform
$21,000.The waste disposal costs are assumed to
ss than $150,000 in Year 1? In Year 5?
t variables. You will use only the Years 1 and 5 cash
part iii.)

mulated distribution of cash flows for Years 1

lying determinants of the project’s cash flows?
me.)
 PROBLEM 3-3ab: Bridgeway Pharmaceuticals

Given
Investment cost (today) $ (400,000)
Project life 5 years
Depreciation expense $ 80,000
Waste disposal cost savings per year $ 18,000
Labor cost savings per year $ 40,000
Sale of reclaimed waste $ 200,000
Required rate of return 20%
Tax rate 35%

Solution
Part a. Year
Cash flow estimation 0 1
Investment $ (400,000)
Waste disposal cost savings per year 18,000
Labor cost savings per year 40,000
Proceeds from sale of reclaimed waste materials 200,000
EBITDA $ 258,000
Less: Depreciation 80,000
Additional EBIT $ 178,000
Less: Taxes 62,300
NOPAT $ 115,700
Plus: Depreciation 80,000
Less: Capex -
Less: Additional working capital -
FCF $ (400,000) $ 195,700

NPV $ 185,263
IRR 39.74%
Analysis NPV of the project is positive and IRR is higher than the required rat

b.
If sale of reclaimed waste drops in half, NPV $ (9,127) To answer part b. simply substitute $100,
sale of reclaimed waste in C10.
Critical B-E for sale of waste materials $ 104,695
Critical B-E Price decline in salvage materials 91.03%
Goal Seek or Solver has been used to find
answer. Details given in text box above.
c. See next worksheet
The terminal period growth rates were estimated such that the intrinsic valuation of the
firm's equity would equal the current market capitalization of the firm using the "Goal
Seek" function.
b: Bridgeway Pharmaceuticals

Solution
Year
2 3 4 5

18,000 18,000 18,000 18,000

40,000 40,000 40,000 40,000
200,000 200,000 200,000 200,000
$ 258,000 $ 258,000 $ 258,000 $ 258,000
80,000 80,000 80,000 80,000
$ 178,000 $ 178,000 $ 178,000 $ 178,000
62,300 62,300 62,300 62,300
$ 115,700 $ 115,700 $ 115,700 $ 115,700
80,000 80,000 80,000 80,000
- - - -
- - - -
$ 195,700 $ 195,700 $ 195,700 $ 195,700

sitive and IRR is higher than the required rate of return therefore project should be accepted

To answer part b. simply substitute $100,000 for the

sale of reclaimed waste in C10.

Goal Seek or Solver has been used to find this

answer. Details given in text box above.
 Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output
 PROBLEM 3-3c: Bridgeway Pharmaceuticals

Given
Investment cost (today) $ (400,000)
Project life 5 years
Depreciation expense $ 80,000
Waste disposal cost savings per year $ 18,000
Labor cost savings per year $ 40,000
Sale of reclaimed waste $ 200,000
Required rate of return 20%
Tax rate 35%
Correlation (Year to year) in Proceeds from reclaimed waste 0.90

Solution
c.
Cash flow estimation 0 1
Investment $ (400,000)
Waste disposal cost savings per year $ 18,000
Labor cost savings per year 40,000
Proceeds from sale of reclaimed waste 198,000
EBITDA $ 256,000
Less: Depreciation 80,000
Additional EBIT $ 176,000
Less: Taxes 61,600
NOPAT $ 114,400
Plus: Depreciation 80,000
Less: Capex -
Less: Additional working capital -
FCF (400,000) $ 194,400

NPV $ 181,375
IRR 39.35% Note: Your results from the simulatio
here where you did not use the same
fact, if you do not "fix" the same seed
Part i. slightly from one simulation of the sa
Preferences/Sampling).
Part ii.

Part iii.
Bridgeway Pharmaceuticals

Solution Legend
= Value given in problem
= Formula/Calculation/Analysis required
= Qualitative analysis or Short answer required
= Goal Seek or Solver cell
= Crystal Ball Input
= Crystal Ball Output

Solution
Year
2 3 4 5

$ 18,000 $ 18,000 $ 18,000 $ 18,000

40,000 40,000 40,000 40,000
198,000 198,000 198,000 198,000
$ 256,000 $ 256,000 $ 256,000 $ 256,000
80,000 80,000 80,000 80,000
$ 176,000 $ 176,000 $ 176,000 $ 176,000
61,600 61,600 61,600 61,600
$ 114,400 $ 114,400 $ 114,400 $ 114,400
80,000 80,000 80,000 80,000
- - - -
- - - -
$ 194,400 $ 194,400 $ 194,400 $ 194,400

ote: Your results from the simulation experiment will differ slightly from those reported
ere where you did not use the same "seed" value for the random number generator. In
ct, if you do not "fix" the same seed value for each simulation your results will differ
ghtly from one simulation of the same problem to another (see Run
eferences/Sampling).