BUSF_A01.qxd

Chapter 6 • Risk in investment appraisal

(1)Initial investment

Starting with the initial investment, putting the symbol I into the equation, instead of £50,000,

and setting the right-hand side of the equation to zero gives:

−l+{5,000 ×[10 −(4 +3)] ×3.791} = 0

l=£56,865

Thus the initial investment could increase by £6,865 before the project would become

marginal. In other words the actual cost of the machine could rise to £56,865 before the pro-

ject would become unattractive, on the basis of its NPV. This assumes that the values of all

of the other input factors (selling price, cost of capital etc.) transpired to be perfect estima-

tions of their actual values.

Now the other factors will be assessed inserting an appropriate symbol and setting the

right-hand side equal to zero.

(2)Annual sales volume

−50,000 +{V×[10 −(4 +3)] ×3.791} = 0

where Vis the annual sales volume.

V==4,396 units

(3)Sales revenue/unit

−50,000 +{5,000 ×[S−(4 +3)] ×3.791} = 0

where Sis the sales revenue per unit.

S= 7 +=£9.64

(4)Labour cost/unit

−50,000 +{5,000 ×[10 −(L+3)] ×3.791} = 0

where Lis the labour cost per unit.

L= 7 −=£4.36

(5)Material cost/unit

−50,000 +{5,000 ×[10 −(4 +M)] ×3.791} = 0

where Mis the material cost/unit.

M= 6 −=50,000 £3.36

5,000 ×3.791

50,000

5,000 ×3.791

50,000

5,000 ×3.791

50,000

(10 −7)×3.791