Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier of highly purified to semiconductors manufactures. A large chip producer has asked Blair to build a new gas production facility close to an existing semiconductor plant.
Once the new gas plant is in place, Blair will be the excusive supplier for that semiconductor fabrication plant for the subsequent 5 years. Blair is considering one of two plant designs. The firsts ?standard? plant which will cost $40 million to build.
The custom will allow Blair to produce their highly specialized gases that are required for and emerging semiconductor manufacturing process.
Blair estimates that its clients will order $10 million of product per year if the traditional plant is constructed, but if the customized is put in place, Blair expects to sell $15 million worth of products annually to it clients. Blair has enough money to build either type of plant, and in the absence of risk difference, accepts the project with the highest NPV.
The cost of capital is 12%.
A) Find the NPV for each project. Are the projects acceptable?
B) Find the breakeven cash inflow for the project.
C) The firm has estimated the probabilities of achieving various ranges of cash inflow for the two projects as shown in the following table.
What is the probability that each project will achieve the breakeven cash inflow found in part b?
Probability of achieving
Cash inflow in given range
Range of cash inflow ($ millions) Standard Plant Custom Plant
$0 to $5 0% 5%
$5 to $8 10 10
$8 to 11 60 15
$11 to 14 25 25
$14 to 17 5 20
$17 to 20 0 15
Above $20 0 10
d) Which project is more risky? Which project has the potentially higher NPV?
Discuss the risk-return trade-offs of the two projects.
e). If the firm wishes to minimize losses (that is, NPV < $0), which project would you recommend? Which would you recommend if the goal were to achieve a higher NPV?