Wk4 Optional
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University of Regina *
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BUSINESS 3
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Finance
Date
Jan 9, 2024
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docx
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Uploaded by MajorGalaxy8136
In Week 4 you will learn investment decision rules and the fundamentals of capital
budgeting. Here are a couple of videos on this topic. Hope these videos are useful.
https://www.youtube.com/watch?v=JE80wLNIhjE
https://www.youtube.com/watch?v=sMKQywwkIjQ
AP # in Workspace Chapter # Problem #
1 8 4
4. Excel Solution Your firm is considering the launch of a new product, the XJ5. The upfront
development cost is $10 million, and you expect to earn a cash flow of $3 million per year for the
next five years. Plot the NPV profile for this project for discount rates ranging from 0% to 30%. For
what range of discount rates is the project attractive?
8-4.
See the table below for the NPVs given different discount rates:
Rate
NPV
0%
$5,000,000
5%
$2,988,430
10%
$1,372,360
15%
$56,465
20%
($1,028,164)
25%
($1,932,160)
30%
($2,693,291)
The project should be accepted as long as the discount rate is below the IRR of 15.238237%.
2 8 8
The Internal Rate of Return Rule
(Note: In most cases, you will find it helpful to use Excel to compute the IRR.)
8. You are considering an investment in a clothes distributor. The company needs $100,000 today and
expects to repay you $120,000 a year from now. What is the IRR of this investment opportunity? Given
the riskiness of the investment opportunity, your cost of capital is 20%. What does the IRR rule say about
whether you should invest?
8-8.
IRR = 120000/100000 – 1 = 20%. You are indifferent
3 9 1
Forecasting Earnings
1. Pisa Pizza, a seller of frozen pizza, is considering introducing a healthier version of its pizza that will be
low in cholesterol and contain no trans fats. The firm expects that sales of the new pizza will be $20
million per year. While many of these sales will be to new customers, Pisa Pizza estimates that 40% will
come from customers who switch to the new, healthier pizza instead of buying the original version.
Assume customers will spend the same amount on either version. What level of incremental sales is
associated with introducing the new pizza?
Suppose that 50% of the customers who will switch from Pisa Pizza’s original pizza to its healthier pizza
will switch to another brand if Pisa Pizza does not introduce a healthier pizza. What level of incremental
sales is associated with introducing the new pizza in this case?
9-1.
a.
Sales of new pizza – lost sales of original = 20 – 0.40(20) = $12 million.
b.
Sales of new pizza – lost sales of original pizza from customers who would not have switched
brands = 20 – 0.50(0.40)(20) = $16 million.
4 9 5
9-5.
Since an increase in NWC is equivalent to a negative cash flow, the cash flow effects are as follows:
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Cash Flow
0
–14
–5
–6
–1
+4
In addition, if NWC reverts back to 0 in year 6, then the “increase” in NWC for year 6 is –22 and the cash
flow caused by the change in NWC is +22. (Note that the sum of the NWC cash flows from years 0 to 6 is
then 0.)
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