Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
Principles of Corporate Finance (Mcgraw-hill/Irwin Series in Finance, Insurance, and Real Estate)
12th Edition
ISBN: 9781259144387
Author: Richard A Brealey, Stewart C Myers, Franklin Allen
Publisher: McGraw-Hill Education
bartleby

Concept explainers

bartleby

Videos

Textbook Question
Book Icon
Chapter 11, Problem 1MC

Libby Flannery, the regional manager of Ecsy-Cola, the international soft drinks empire, was reviewing her investment plans for Central Asia. She had contemplated launching Ecsy-Cola in the ex-Soviet republic of Inglistan in 2019. This would involve a capital outlay of $20 million in 2018 to build a bottling plant and set up a distribution system there. Fixed costs (for manufacturing, distribution, and marketing) would then be $3 million per year from 2018 onward. This would be sufficient to make and sell 200 million liters per year—enough for every man, woman, and child in Inglistan to drink four bottles per week! But there would be few savings from building a smaller plant, and import tariffs and transport costs in the region would keep all production within national borders.

The variable costs of production and distribution would be 12 cents per liter. Company policy requires a rate of return of 25% in nominal dollar terms, after local taxes but before deducting any costs of financing. The sales revenue is forecasted to be 35 cents per liter.

Bottling plants last almost forever, and all unit costs and revenues were expected to remain constant in nominal terms. Tax would be payable at a rate of 30%, and under the Inglistan corporate tax code, capital expenditures can be written off on a straight-line basis over four years.

All these inputs were reasonably clear. But Ms. Flannery racked her brain trying to forecast sales. Ecsy-Cola found that the “1–2–4” rule works in most new markets. Sales typically double in the second year, double again in the third year, and after that remain roughly constant. Libby’s best guess was that, if she went ahead immediately, initial sales in Inglistan would be 12.5 million liters in 2020, ramping up to 50 million in 2022 and onward.

Ms. Flannery also worried whether it would be better to wait a year. The soft drink market was developing rapidly in neighboring countries, and in a year’s time she should have a much better idea whether Ecsy-Cola would be likely to catch on in Inglistan. If it didn’t catch on and sales stalled below 20 million liters, a large investment probably would not be justified.

Ms. Flannery had assumed that Ecsy-Cola’s keen rival. Sparky-Cola, would not also enter the market. But last week she received a shock when in the lobby of the Kapitaliste Hotel she bumped into her opposite number at Sparky-Cola. Sparky-Cola would face costs similar to Ecsy-Cola. How would Sparky-Cola respond if Ecsy-Cola entered the market? Would it decide to enter also? If so, how would that affect the profitability of Ecsy-Cola’s project?

Ms. Flannery thought again about postponing investment for a year. Suppose Sparky-Cola were interested in the Inglistan market. Would that favor delay or immediate action?

Maybe Ecsy-Cola should announce its plans before Sparky-Cola had a chance to develop its own proposals. It seemed that the Inglistan project was becoming more complicated by the day.

Calculate the NPV of the proposed investment, using the inputs suggested in this case. How sensitive is this NPV to future sales volume?

Blurred answer
Students have asked these similar questions
General Finance Question
Consider the following simplified financial statements for the Yoo Corporation (assuming no income taxes): Income Statement Balance Sheet Sales Costs $ 40,000 Assets 34,160 $26,000 Debt Equity $ 7,000 19,000 Net income $ 5,840 Total $26,000 Total $26,000 The company has predicted a sales increase of 20 percent. Assume Yoo pays out half of net income in the form of a cash dividend. Costs and assets vary with sales, but debt and equity do not. Prepare the pro forma statements. (Input all amounts as positive values. Do not round intermediate calculations and round your answers to the nearest whole dollar amount.) Pro forma income statement Sales Costs $ 48000 40992 Assets $ 31200 Pro forma balance sheet Debt 7000 Equity 19000 Net income $ 7008 Total $ 31200 Total 30304 What is the external financing needed? (Do not round intermediate calculations. Negative amount should be indicated by a minus sign.) External financing needed $ 896
An insurance company has liabilities of £7 million due in 10 years' time and £9 million due in 17 years' time. The assets of the company consist of two zero-coupon bonds, one paying £X million in 7 years' time and the other paying £Y million in 20 years' time. The current interest rate is 6% per annum effective. Find the nominal value of X (i.e. the amount, IN MILLIONS, that bond X pays in 7 year's time) such that the first two conditions for Redington's theory of immunisation are satisfied. Express your answer to THREE DECIMAL PLACES.
Knowledge Booster
Background pattern image
Finance
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.
Similar questions
SEE MORE QUESTIONS
Recommended textbooks for you
Text book image
Managerial Accounting
Accounting
ISBN:9781337912020
Author:Carl Warren, Ph.d. Cma William B. Tayler
Publisher:South-Western College Pub
Text book image
Financial And Managerial Accounting
Accounting
ISBN:9781337902663
Author:WARREN, Carl S.
Publisher:Cengage Learning,
Capital Budgeting Introduction & Calculations Step-by-Step -PV, FV, NPV, IRR, Payback, Simple R of R; Author: Accounting Step by Step;https://www.youtube.com/watch?v=hyBw-NnAkHY;License: Standard Youtube License