Breakeven cash inflows and risk Blair Gasses and Chemicals is a supplier of highly purified gases to semiconductor manufacturers. 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 exclusive supplier for that semiconductor fabrication plant for the subsequent 5 years. Blair is considering one of two plant designs. The first is Blair’s “standard” plant, which will cost $30 million to build. The second is for a “custom” plant, which will cost $40 million to build. The custom plant will allow Blair to produce the highly specialized gases that are required for an emerging semiconductor manufacturing process. Blair estimates that its client will order $10 million of product per year if the traditional plant is constructed, but if the customized design is put in place, Blair expects to sell $15 million worth of product annually to its client. Blair has enough money to build either type of plant, and, in the absence of risk differences, 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 each project.
c. The firm has estimated the probabilities of achieving various ranges of cash inflows or the two projects as shown in the following table. What is the probability that each project will achieve at least the breakeven cash inflow found in part b?
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 wished to minimize losses (that is, NPV 6 $0), which project would you recommend? Which would you recommend if the goal were to achieve a higher NPV?