1. Description:
An investment program is going to produce two products, A and B. The
program has the following characteristics:
• Construction period 2 years. Service (operating) life 15 years after the
end of the construction period.
• Construction costs € 100 million during the first year and € 150 million
during the second.
• Depreciation: The investment corresponding at the first year of the
construction period will be fully depreciated in 10 years and the
investment corresponding to the second in 15 years both in equal
amounts. Depreciation begins with the start of commercial operation
(third year). At the end of the project’s operational life it is estimated that
the equipment can be sold for 5 million €.
• Timing of the cash-flow: Inflows and outflows are assumed to occur at
the end of each year.
• Product A: Annual production at full capacity 1m units a year and
estimated unit selling price of 30 € for the entire operational life of the
project.
• Product B: Annual production at full capacity of 1 million units per year
and estimated unit selling price of 40 € for the entire operational life of
the project.
• Production profile: For both products at the first year of commercial
operation annual production will be at 50% of full production capacity,
at the second year at 75% and from the third year until the end of
service life production will be at 100% of full production capacity.
• Operating costs are estimated at 10 € per unit for A and 12 € per unit
for B plus 10% in the form of taxes for A and B which are paid by the
investor. Operating costs are stable throughout the operational life of
the project and are stable throughout the operational life of the project.
• Maintenance: At the10th of the project’s life it is expected that
maintenance / upgrade would cost 5 million €.
• Taxation: There is a tax rate of 40% on ‘profits before tax’.

2. • We assume that all the values involved in the investment vary at the
same rate with annual rate of change of the general price index, which
is estimated for the period of the investment at 1.0%.
• Sources of finance:
(1) 60% from loans with a nominal annual interest rate of 7% and the
tax rate on profits of 40%.
(2) 40% from retained earnings. The current price of the company’s
stock is 60€/share, the next year dividend is expected to be 5€, and
over the long run the annual dividend growth for this firm is estimated
at 0.5%.
• Environmental impact:
(1) The production processes used is expected to save energy relative
to traditional methods. Energy savings correspond to the savings of
100,000tn/CO2 per year. The current price of carbon allowances in the
European Union Emission Trading Scheme is 7€/tnCO2 and is
expected to increase at a rate of 1% annually for the next 15 years.

3. Analysis
First we construct the cash-flows table including all the inflows and
outflows relevant to the project. In order to perform financial analysis,
which is an assessment of the (1) effectiveness with which funds
(investment and debt) are employed, (2) efficiency and profitability of its
operations, and (3) value and safety of debtors' claims against the firm's
assets, and economic analysis, which is a systematic approach to
determining the optimum use of scarce resources, involving
comparison of two or more alternatives in achieving a specific objective
under the given assumptions and constraints (it takes into account the
opportunity costs of resources employed and attempts to measure in
monetary terms the private and social costs and benefits of a project to
the community or economy), we calculate financial and economic cash-
flows, costs, benefits and cumulative financial cash flows. We also
calculate WACC and the real cost of capital. Using the above we can
calculate the following:
Financial NPV 74.274.299 €
B/C 1,14
Financial IRR 9%
Payback Period 9,6
Economic NPV @ 5% 277.470.378 €
Economic NPV @ 7,5% 189.344.457 €
IRR 19%
After that we calculate the Social Discount Rate. Using the Ramsey
formula we find that the SDR is 4.75%. We see that the SDR is very
close to the European Commission benchmark and lower than the IRR

4. which means that the project is very likely to be funded because the risk
of project benefits not been reaped is lower.
Then in order to check the financial stability of the project we create a
second table in which we calculate total inflows and total outflows. Next
we find the net cash flow and the cumulative net cash flow. The
conclusion is that the project is financially stable because the cash flows
it produces are sufficient.
Next we perform risk analysis using Sensitivity analysis with critical
variable the cost of capital and we have the following results:
1. Financial NPV
The data shows that the cost of capital is a critical variable when
its values are close to the value that is used in the exercise.
WACC FNPV ΔFNPV
0,03 128.951.713 € -
0,04 100.338.647 € 22%
0,05 75.213.496 € 25%
0,06 53.116.783 € 29%
(€100000000,0)
(€50000000,0)
€,0
€50000000,0
€100000000,0
€150000000,0
€200000000,0
€250000000,0
0 0,02 0,04 0,06 0,08 0,1 0,12 0,14 0,16
financialnpv
cost of capital
SensIt 1.40 Academic Version

5. The graph shows us that as the cost of capital increases it becomes
less critical. It can also be seen the crossover point which is in
agreement with the calculation for the IRR.
2. Economic NPV at 5% and 7.5%
Cost of Capital ENPV ΔENPV
0,04 321.083.472 € -
0,05 277.470.378 € 14%
0,06 238.962.204 € 14%
0,07 204.894.399 € 14%
0,08 174.697.759 € 15%
0,09 147.883.623 € 15%
Again the cost of capital is critical for values near 5% and 7.5% and the
crossover point is at 19% in agreement with the calculations.
(€100000000,0)
€,0
€100000000,0
€200000000,0
€300000000,0
€400000000,0
€500000000,0
€600000000,0
0 0,05 0,1 0,15 0,2 0,25 0,3
economicnpv@5%
cost of capital
SensIt 1.40 Academic Version

6. Finally we perform risk analysis using Monte Carlo simulation assigning
distribution values to construction cost. The variations of the NPV with
respect to the random values of the construction cost are displayed
below.

7. As can be seen the possibility of getting a zero NPV is approximately
zero.