Foundations Of Finance
10th Edition
ISBN: 9780134897264
Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher: Pearson,
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Chapter 11, Problem 18SP
(Real options and capital budgeting) McDoogals Restaurants has come up with a new fast-food, casual restaurant combining some of the features of Chipotle, Panera, and Shake Shack, but it is not quite sure how the public will react to it. McDoogals feels that there is a 50–50 chance that consumers will like it and a 50–50 chance that they won’t. McDoogals is considering building one of these new restaurants; the cash flows if it succeeds and if it fails are given below.
The required
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A company is going to start a pop-up venture. The goal is to break-even and use the experience to learn about how consumers react to types of green products. The project will cost $2,000 to implement and will have after-tax cash flows of $200 at the end of Year 1 and $2,200 after Year 2. At that time the project will end. The $2,000 investment will be financed 50% debt and 50% equity. The before-tax cost of debt is 8%. The tax rate is 20%. The beta for the project is 1.2. The risk-free rate for computing the cost of equity is 5.2% and the market risk premium is 7%.
Use this information to:
Find the WACC for the project.
Show that this is a zero NPV project.
Show that debtholders and shareholders both earn their minimum required rates of return.
Year
Cash flow
Present Value
to Debt
to Equity
0
-2000
1
200
2
2200
When McDonalds consider the new store, the management know that KFC might also considering opening a new store at the same place. McDonalds predicts that the future cash flow will be 630,000 with probability 50% if KFC does not open a new store, and 210,000 with probability 50% if KFC does.
Should McDonalds undertakes the project?
Consider two mutually exclusive R&D projects that Savage Tech is considering. Assume the discount rate for both projects is 8 percent.
Project A:
Server CPU .13 micron processing project
By shrinking the die size to .13 micron, the company will be able to offer server CPU chips with lower power consumption and heat generation, meaning faster CPUs.
Project B:
New telecom chip project
Entry into this industry will require introduction of a new chip for cell phones. The know-how will require a large amount of up-front capital, but success of the project will lead to large cash flows later on.
Year
Project A
Project B
0
–$
705,000
–$
910,000
1
340,000
255,000
2
355,000
360,000
3
255,000
360,000
4
180,000
410,000
5
120,000
495,000
Complete the following table: (Do not round intermediate calculations. Enter the IRR as a percent. Round your profitability index (PI) answers to 3 decimal places,…
Chapter 11 Solutions
Foundations Of Finance
Ch. 11.A - Prob. 1MCCh. 11.A - Prob. 2MCCh. 11 - Prob. 1RQCh. 11 - Prob. 2RQCh. 11 - If a project requires an additional investment in...Ch. 11 - Prob. 4RQCh. 11 - Prob. 5RQCh. 11 - Prob. 6RQCh. 11 - Prob. 1SPCh. 11 - (Relevant cash flows) Captins Cereal is...
Ch. 11 - Prob. 3SPCh. 11 - Prob. 4SPCh. 11 - Prob. 5SPCh. 11 - Prob. 6SPCh. 11 - Prob. 7SPCh. 11 - Prob. 9SPCh. 11 - Prob. 10SPCh. 11 - Prob. 11SPCh. 11 - Prob. 12SPCh. 11 - Prob. 15SPCh. 11 - (Real options and capital budgeting) You have come...Ch. 11 - (Real options and capital budgeting) Go-Power...Ch. 11 - (Real options and capital budgeting) McDoogals...Ch. 11 - (Risk-adjusted NPV) The Hokie Corporation is...Ch. 11 - (Risk-adjusted discount rates and risk classes)...Ch. 11 - Prob. 1MCCh. 11 - Prob. 2MCCh. 11 - Prob. 3MCCh. 11 - Prob. 7MCCh. 11 - Prob. 8MCCh. 11 - Prob. 9MCCh. 11 - Should the project be accepted? Why or why not?Ch. 11 - Prob. 11MCCh. 11 - Prob. 12MCCh. 11 - Prob. 13MCCh. 11 - Prob. 14MC
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