P Ltd, a manufacturing company, is considering a new capital investment project to set up a new production line.
The initial appraisal shows a healthy net present value of $6,465 million at a discount rate of 10% as shown in the table below:
However, management is unsure about the demand for the product which will be produced and has insisted that the future revenues should be reduced to certainity equivalents by taking 70%, 65% and 60% of the years 1,2, and 3 cash inflows respectively.
What should P do?
A . Proceed with the project, it has a healthy net present value.
B . Stop the project, it has considerable risk.
C . Put pressure on sales and marketing to re-verify their forecasts.
D . Re-appraise the project using other capital appraisal techniques to get a more balanced view.
Answer: D
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