The Bertz Merchandising Company uses a simulation approach to judge investment projects. Three factors are employed: market demand, in units; price per unit minus cost per unit (on an after-tax basis); and investment required at time 0. These factors are felt to be independent of one another. In analyzing a new "fad" consumer product with a one-year product life, Bertz estimates the following probability distributions:
|
MARKET DEMAND
|
PRICE MINUS COST
PER UNIT(After-tax)
|
INVESTMENT REQUIRED
|
|
PROBABILITY
|
UNITS
|
PROBABILITY
|
DOLLARS
|
PROBABILITY
|
DOLLARS
|
|
0.15
|
26,000
|
0.30
|
$6.00
|
0.30
|
$160,000
|
|
0.20
|
27,000
|
0.40
|
6.50
|
0.40
|
165,000
|
|
0.30
|
28,000
|
0.30
|
7.00
|
0.30
|
170,000
|
|
0.20
|
29,000
|
1.00
|
|
1.00
|
|
|
0.15
|
30,000
|
|
|
|
|
|
1.00
|
|
|
|
|
|
a. Using a table of random numbers or some other random process, simulate 20 or more trials of these three factors, and compute the internal rate of return on this one-year investment for each trial.
b. Approximately, what is the most likely return? How risky is the project?