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Scenario Analysis Case:

Fertilizer industry in Pakistan is currently facing sheer competition. Players in the


fertilizer industry are offering huge discounts on Urea. FFC is unable to manage
discounts as it has higher variable cost per unit of production. The reason behind
the higher variable cost is unavailability of cheap gas which is available to its
competitors. Inability of the company to offer the discounts has resulted in
reduced unit sales, Profit Margins and return. The company is unable to manage
the profit streams and is currently facing huge losses. Company directors and
senior management is very anxious on the poor performance of the company
and they are thinking to bring some changes in the production process and
equipment which can reduce variable cost. On this, production manager has
prepared a complete report on how the company can reduce the variable cost
marginally to stay competitive in the market. Production manager suggests to
buy a new machinery cost Rs. 180 million and another cost relevant to making
the machinery available for use will amount Rs 20 million. Which will reduce the
variable cost of the company by Rs. 50 per unit and will enhance the production
capacity of the company by 25%, which incremental sales of 25,000 bags of urea
per year for the next 8 years.
Experts of the company have discussed the probability of different situations that
might occur keeping in view the current condition of the economy and Industry.
Data for each variable in different scenario is given as follows. You being finance
manager in the company have been assigned the responsibility to analyse the
project. Directors have asked you to calculate NPV of the project and to see
whether the project will increase the value of the company or not? And can it be
helpful in improving current situation of the company. You are therefore asked to
run the complete scenario analysis of the project to see how will the company
fluctuate with changes to different market conditions. You are also asked to give
your recommendations whether the company should go for the project or not.

Before After Replacement


Replaceme
nt
Name Initial Data Base Worst Best Case
Case Case
Probability 0.6 0.2 0.2

Equipment cost 200,000,0 220,000,0 180,000,00


00 00 0
Depreciation 500,000 Double Declining Method (20% per
year)
Salvage value 500,000 500,000 500,000
Units sold (year 1) 300,000 375,000 275,000 450,000
Annual change in units 0.05 0.05 0.04 0.08
sold
Sales Price 1400 1400 1400 1500
Change in Sales Price 0.04 0.04 0.04 0.04
Variable Cost per unit 1150 1100 1150 1050
Change in Variable cost 0.04 0.04 0.04 0.04
Fixed Cost 2,000,000 2,000,000 2,300,000 1,800,000
Change in Fixed cost 0.04 0.04 0.04 0.04
Project WACC 12% 12% 12% 12%
Tax Rate 0.3 0.3 0.3 0.3
Working capital as % of 0 0.08 0.08 0.08
next year sales
Life of newly purchased 8 8 8
Machine
Depreciation Rate 0.2 0.2 0.2

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