Tremont Case Writeup
I recommend the lease option for Tremont. This is because while the lease option offers a remotely smaller, it is also much less risky.
To start, the lease option has a much higher IRR (around 45%) and the IRR barely fluctuates from scenario to scenario. This means that no matter how much the discount rate changes the project is still safe. On the other Hand the base IRR for the build option is about 22% and fluctuates greatly from scenario to scenario. There is a scenario in which the WACC changes independently off all other variables to about 22%. In this situation, the build option would provide an NPV of around $17,000. That NPV while positive is nowhere near what Tremont would like out of their investment. The base IRR for the build option is low because it generates most of its value in the later years of the project. This makes it more sensitive to changes in the discount rate.
The WACC can go as low as 25% below the base value and as high as 75% above the base value. The higher the WACC the lower the NPV. The build option has a number of scenarios that put its NPV extremely low and even negative in many case. In the event that the WACC drops 25% the NPV for the build option rises greatly. However, there are more situations in which the WACC rises than falls. Therefore there are also more situations in which the build option is at risk of a bad NPV.
With the high initial investment scenario, the build option’s IRR drops to about 18%. In this case it would only take a 50% increase in the WACC to cause a negative NPV. A low initial investment would raise the build option’s IRR by a similar margin to about 27%. For the lease option’s high initial investment scenario, the IRR is still far above the discount rate.
The build option has an extra input variable that exacerbates the worst case scenario. Their cash flows are dependent on their own success. If their sales drop in the first year from 175,000 to 150,000, their IRR will also drop
To start, the lease option has a much higher IRR (around 45%) and the IRR barely fluctuates from scenario to scenario. This means that no matter how much the discount rate changes the project is still safe. On the other Hand the base IRR for the build option is about 22% and fluctuates greatly from scenario to scenario. There is a scenario in which the WACC changes independently off all other variables to about 22%. In this situation, the build option would provide an NPV of around $17,000. That NPV while positive is nowhere near what Tremont would like out of their investment. The base IRR for the build option is low because it generates most of its value in the later years of the project. This makes it more sensitive to changes in the discount rate.
The WACC can go as low as 25% below the base value and as high as 75% above the base value. The higher the WACC the lower the NPV. The build option has a number of scenarios that put its NPV extremely low and even negative in many case. In the event that the WACC drops 25% the NPV for the build option rises greatly. However, there are more situations in which the WACC rises than falls. Therefore there are also more situations in which the build option is at risk of a bad NPV.
With the high initial investment scenario, the build option’s IRR drops to about 18%. In this case it would only take a 50% increase in the WACC to cause a negative NPV. A low initial investment would raise the build option’s IRR by a similar margin to about 27%. For the lease option’s high initial investment scenario, the IRR is still far above the discount rate.
The build option has an extra input variable that exacerbates the worst case scenario. Their cash flows are dependent on their own success. If their sales drop in the first year from 175,000 to 150,000, their IRR will also drop