You run a perpetual encabulator machine, which generates revenues averaging $28 million per year. Raw material costs are 50% of revenues. These costs are variable-they are always proportional to revenues. There are no other operating costs. The cost of capital is 13%. Your firm's long-term borrowing rate is 10%. Now you are approached by Studebaker Capital Corp., which proposes a fixed-price contract to supply raw materials at $14.00 million per year for 9 years. a. What happens to the operating leverage and business risk of the encabulator machine if you agree to this fixed-price contract? Operating leverage and business risk increases Operating leverage and business risk decreases b. Calculate the present value of the encabulator machine with and without the fixed-price contract. (Do not round Intermediate calculations. Enter your answers in dollars not in millions. Round your answers to the nearest whole dollar amount.) With contract Without contract Present Value

Intermediate Financial Management (MindTap Course List)
13th Edition
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Eugene F. Brigham, Phillip R. Daves
Chapter12: Capital Budgeting: Decision Criteria
Section: Chapter Questions
Problem 21P: Your division is considering two investment projects, each of which requires an up-front expenditure...
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You run a perpetual encabulator machine, which generates revenues averaging $28 million per year. Raw material costs are 50% of
revenues. These costs are variable-they are always proportional to revenues. There are no other operating costs. The cost of capital
is 13%. Your firm's long-term borrowing rate is 10%.
Now you are approached by Studebaker Capital Corp., which proposes a fixed-price contract to supply raw materials at $14.00 million
per year for 9 years.
a. What happens to the operating leverage and business risk of the encabulator machine if you agree to this fixed-price contract?
Operating leverage and business risk increases
Operating leverage and business risk decreases
b. Calculate the present value of the encabulator machine with and without the fixed-price contract. (Do not round Intermediate
calculations. Enter your answers in dollars not in millions. Round your answers to the nearest whole dollar amount.)
With contract
Without contract
Present Value
Transcribed Image Text:You run a perpetual encabulator machine, which generates revenues averaging $28 million per year. Raw material costs are 50% of revenues. These costs are variable-they are always proportional to revenues. There are no other operating costs. The cost of capital is 13%. Your firm's long-term borrowing rate is 10%. Now you are approached by Studebaker Capital Corp., which proposes a fixed-price contract to supply raw materials at $14.00 million per year for 9 years. a. What happens to the operating leverage and business risk of the encabulator machine if you agree to this fixed-price contract? Operating leverage and business risk increases Operating leverage and business risk decreases b. Calculate the present value of the encabulator machine with and without the fixed-price contract. (Do not round Intermediate calculations. Enter your answers in dollars not in millions. Round your answers to the nearest whole dollar amount.) With contract Without contract Present Value
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