Solve the following problem:
Southeastern Freight Lines (SFL), as the name suggests, is a less-than-truckload freight-hauling firm that works in the Southeastern United States as well as Puerto Rico and the U.S. Virgin Islands. This family owned company is considering the installation of a two-way mobile satellite messaging service on its 1,500 trucks. A pilot test conducted on 150 trucks by the company last year found that satellite messaging could cut 60% of its $5 million bill for long-distance communications with truck drivers. Moreover, because of this system the drivers reduced the number of "deadhead" miles-those driven without paying loads-by 0.5%. Applying that improvement to all 230 million miles covered by the SFL fleet each year would produce an extra $1.25 million in savings.
Equipping all 1,500 trucks with the satellite hookup will require an investment of $8 million and the construction of a message-relaying system costing $2 million. The equipment and on-board devices will have a service life of eight years and negligible salvage value; they will be depreciated under the five-year MACRS class. SFL's marginal tax rate is about 38%, and its required minimum attractive rate of return is 18%.
a) Determine the annual net cash flows from the project and make a decision regarding the attractiveness of the project based on the project's NPV.
b) Perform a sensitivity analysis by varying savings in the telephone bill to determine the resultant impact on the project's NPV. Assume that the telephone bill savings can deviate from its base-case expected value by +/-10 %, +/-20%, and +/-30%. Interpret the results of your sensitivity analysis.
c) Perform a scenario analysis on the project's NPV by comparing the base case to the following two scenarios then interpret the results .
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Worst Case Scenario
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Best Case Scenario
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Savings in the Telephone Bill
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-30%
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+30%
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Savings in Deadhead Miles
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-20%
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+30%
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Tax Rate
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45%
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25%
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d) Assume that there is a 25% chance that the worst case scenario will occur, a 15% chance that the best case scenario will occur, and a 60% chance that the original (or base case) scenario will occur. What is the expected NPV and the associated measure of risk?
e) Use the Certainty Equivalent Method (CEM) to take into account the risk associated with the project assuming the same three scenarios used in part c). Assume that the risk free rate is 5% and the following certainty equivalent coefficients :
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COV
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1
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2
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3
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4
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5
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6
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7
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8
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1
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<= 0.1
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0.95
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0.92
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0.89
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0.85
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0.80
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0.75
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0.70
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0.64
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2
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0.1 < COV <= 0.2
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0.90
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0.85
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0.82
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0.75
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0.70
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0.65
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0.60
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0.54
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3
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>0.2
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0.80
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0.85
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0.75
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0.70
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0.65
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0.60
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0.55
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0.49
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Use the project financials model that you developed in part a) to fill out the cash flows for each scenario in order to conduct your analysis using the CEM.
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Outcome
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Probability
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CF0
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CF1
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CF2
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CF3
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CF4
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CF5
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CF6
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CF7
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CF8
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Base
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60%
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Worst
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25%
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Best
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15%
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