1. Now assume that first year units sold follows the probability distribution.
Probability Units Sold 0.25 130,000 0.50 110,000 0.25 100,000
Conduct a scenario analysis and examine both NPV and IRR. As part of this analysis, you should calculate expected values and the appropriate risk measures. Also, give the probability that this project will have a negative NPV and the IRR is less than the WACC assuming a normal distribution.
2. AA’s accountant remembers that one approach used to adjust for risk is to focus on the cost of capital estimate. An ad hoc approach is to classify projects as high, average or low risk based on the coefficient of variation of the project. For this analysis, assume that if the absolute value of the coefficient of variation is less than 0.97, the project is low risk. If it is between 0.97 and 1.17, the project has average risk, and if it is greater than 1.17, the project is considered high risk. For low risk projects, the WACC is reduced by 5 percentage points. If the project is considered high risk, the WACC is increased by 5 percentage points. Use the results from (5) and the NPV’s coefficient of variation to determine the WACC of this project. What are the revised decision criteria for the project under this approach? What are your thoughts regarding this approach?
3. Based on your set of analyses in this case, what is your overall impression of the new airbag? What is your recommendation to AA?