Please answer each of the following questions with your explanations:
I. Explain the purpose and steps of the Benefit – Cost Analysis in detail. Make sure
to explain when this method is preferred, what are the steps you would take to
conduct a benefit cost analysis if projects are independent versus if projects are
mutually exclusive?
II. Please solve the following problem:
There is a river that experiences periodic flood damage. This happens almost every
two years and results in a loss of $3 million. One option is to straighten and deepen
the river, which will cost $3,4 million, to reduce the probable damage to not over
$1,8 million for each occurrence during a period of 15 years before it would have
to be deepened again. This would have $90 thousand of annual maintenance
expenses. An alternative option is to construct a flood-control dam at a cost of $6,5
million. This alternative would have maintenance costs (annual) of $65 thousand.
He estimates that this project would reduce the probable annual flood damage to
not over $600 thousand. If this option is chosen irrigation water would produce
annual revenue of $300 thousand. A third alternative is to build the dam and the
river channel. The cost would be $9,9 million. Then, probable annual flood loss
would be reduced to not over $250 thousand while providing the same irrigation
and recreational benefits. If the cost of capital is worth 10%, determine the Benefit
– Cost ratios and the incremental Benefit-Cost ratio.
According to your findings please recommend which alternative should be adopted,
one of the alternatives has to be chosen.
III. Please explain the sensitivity analysis and identify the steps for one factor as well
as multifactor case.
IV. Please solve the following problems:
Asli Togan Egrican
a. A few investors borrowed $25 million to build 600 new apartments near a mall.
They borrowed at 10% interest and the loan is to be repaid in equal annual
amounts over a 30-year period. Per apartment, maintenance expenses per year
are $6,000. The rental fee for each apartment will be $14,000 per year, and the
worst-case occupancy rate is projected to be 80%.
Please analyze the sensitivity of annual profit (or loss) to (a) changes in the
occupancy rate (you can try 60, 65, 70, 75, 80, 85, 90, 95, 100 percent one by
one) and (b) changes in the annual rental fee (you can try $10, $12, $14, $16,
$18k one by one). Please create a table showing the changes in annual profit.
b. Suppose the following are possible states for an investment:

Optimistic Most Likely Pessimistic
Capital investment $60,000 $110,000 $125,000
Useful life 12 years 9 years 6 years
Market value $30,000 $25,000 $0
Net annual cash flow $45,000 $28,000 $20,000
MARR (per year) 10% 10% 10%
a. What is the annual worth (AW) for each of the three estimation conditions?
b. It is thought that the most critical factors are useful life and net annual cash flow.
Develop a table showing the net AW for all combinations of the estimates for these
two factors, assuming all other factors to be at their most likely values.
V. Please explain the following in your own words:
a. The difference between Risk and Uncertainty
b. Monte Carlo Simulations- when we use it and how we use it including the steps
(You can use an example to explain)
c. Real Options Analysis using Decision Trees-when do we use it how do we use
it
VI. Please solve the following problem:
A firm must decide between constructing a new facility or renting a comparable office
space. There are two random outcomes for acquiring space, as shown in figure below. Each
would accommodate the expected growth of this company over the next 10 years. The cost
of rental space is expected to escalate over the 10 years for each rental outcome. The option
of constructing a new facility is also defined in figure below. An initial facility could be
constructed with the costs shown. In five years, additional space will be required. At that
time, there will be an option to build an office addition or rent space for the additional space
requirements. The probabilities for each alternative are shown. MARR for the situation is
15% per year. A PW analysis is to be conducted on the alternatives. Which course of action
should be recommended? Note: At 2, the PW(15%) of the upper branch is −$5,513.00 k
and the PW(15%) for the lower branch is −$3,830.00 k.