INTERMEDIATE FINANCIAL MANAGEMENT
12th Edition
ISBN: 9781305718265
Author: Brigham
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Textbook Question
Chapter 14, Problem 3MC
Tropical Sweets is considering a project that will cost $70 million and will generate expected cash flows of $30 million per year for 3 years. The cost of capital for this type of project is 10%, and the risk-free rate is 6%. After discussions with the marketing department, you learn that there is a 30% chance of high demand with associated future cash flows of $45 million per year. There is also a 40% chance of average demand with cash flows of $30 million per year as well as a 30% chance of low demand with cash flows of only $15 million per year. What is the expected
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
Consider the following project data. A marketing study that costs $200 will be conducted at t = 0. The best estimate now is that there is a 70 percent chance that the study will indicate potential and a 30 percent chance that it will not. If the study indicates potential, the firm will spend $500 at t = 1 to start production. If the firm starts production, the firm is confident that cash inflows will be $1,000 annually for two years (t=2 and 3). If the appropriate cost of capital is 10 percent, what is the project's expected NPV to the nearest dollar?
A) $1,300
B) $923
C) $646
D) $586
E) $446
A project that costs $1000 today is expected to have cash flows of $200/year for 10 years.
Under these projections, this is a positive NPV project: if your cost of capital is 10%/year, investing $1000 today and earning $200 per year for 10 years yields an NPV of $228.91 (you can verify this yourself, or take my word for it).
However, those annual cash flows of $200 are based on the following expectations:
A 50% probability that business will be good and the project will earn $300/year, and
a 50% probability that business will be bad and the project will earn $100/year.
(Note that the expected annual cash flows will be: [0.5 * $300] + [0.5 * $100] = $200/year, as stated above.)
Unfortunately, you will not know which state of the world you will be in until you spend the $1000 and start the business; in year 1, after the business opens, you will find out.
Obviously, if you open for business and business is good, you will want to stay open for the entire 10 years; if your cost of capital…
You are considering opening a new plant. The plant will cost $98.52 million up front and will
take one year to build. After that, it is expected to produce profits of $30.46 million at the
end of every year of production. The cash flows are expected to last forever. Calculate the
NPV of this investment opportunity if your cost of capital is 8.25%. Should you make
the investment? Calculate the IRR and use it to determine the maximum deviation
allowable in the cost of capital estimate to leave the decision unchanged.
The NPV of the project will be $ million. (Round to two decimal places.)
Chapter 14 Solutions
INTERMEDIATE FINANCIAL MANAGEMENT
Ch. 14 - Prob. 1QCh. 14 - Prob. 2QCh. 14 - Prob. 3QCh. 14 - If a company has an option to abandon a project,...Ch. 14 - Prob. 3PCh. 14 - Investment Timing Option: Option Analysis
Rework...Ch. 14 - Prob. 7PCh. 14 - Prob. 1MCCh. 14 - What are five possible procedures for analyzing a...Ch. 14 - Tropical Sweets is considering a project that will...
Knowledge Booster
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
- Jasmine Manufacturing is considering a project that will require an initial investment of $52,000 and is expected to generate future cash flows of $10,000 for years 1 through 3, $8,000 for years 4 and 5, and $2,000 for years 6 through 10. What is the payback period for this project?arrow_forwardBuena Vision Clinic is considering an investment that requires an outlay of 600,000 and promises a net cash inflow one year from now of 810,000. Assume the cost of capital is 10 percent. Required: 1. Break the 810,000 future cash inflow into three components: a. The return of the original investment b. The cost of capital c. The profit earned on the investment 2. Now, compute the present value of the profit earned on the investment. 3. Compute the NPV of the investment. Compare this with the present value of the profit computed in Requirement 2. What does this tell you about the meaning of NPV?arrow_forwardYou are considering opening a new plant. The plant will cost $97.5 million up front and will take one year to build. After that it is expected to produce profits of $29.1 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 8.8%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. The NPV of the project will be $ million. (Round to one decimal place.)arrow_forward
- Celestial Crane Cosmetics is analyzing a project that requires an initial investment of $3,225,000. The project's expected cash flows are: Year Cash Flow Year 1 $375,000 Year 2 -125,000 Year 3 500,000 Year 4 400,000 If the company's WACC is 8% and the project has the same risk as the firm's average project, what is the project's modified internal rate of return (MIRR)? Should you accept or reject this project?arrow_forwardYou are considering opening a new plant. The plant will cost $95.1 million up front and will take one year to build. After that it is expected to produce profits of $31.8 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 7.6%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. The NPV of the project will be $ million. (Round to one decimal place.)arrow_forwardHansen Pharmaceuticals is considering development of a potential new drug. Testing will cost $31 million today. If the tests are successful, the company will invest $110 million into production and final development starting one year from now. Following that investment, the drug should produce cash flows of $61 million per year for the next 9 years. What is the NPV of this project, assuming the appropriate discount rate is 20% and the initial tests have a 40% chance of success? Don't round steps. 2 decimal answer. NPV = $ Suppose Hansen Pharmaceuticals has the option to sell their research for $1 million in the event of an unsuccessful test. What is the value of this option to abandon? Don't round steps. 2 decimal answer. Option to Abandon = $arrow_forward
- You are considering opening a new plant. The plant will cost $100.3 million up front and will take one year to build. After that it is expected to produce profits of $29.8 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 7.2%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. The NPV of the project will be $ million. (Round to one decimal place.) make the investment. (Select from the drop-down menu.) You The IRR is%. (Round to two decimal places.) The maximum deviation allowable in the cost of capital estimate is%. (Round to two decimal places.)arrow_forwardA firm is considering investing in a project that will cost $700,000. Then the project will provide positive cash flows of $200,000 per year for four years. The firm has a WACC of 12.5%. What is the Payback Period of this Project?arrow_forwardA project has expected cash flows with a present value of $75 million. The annual standard deviation of the project's returns is 35%. The company can delay the start of the project by 1 year to find out more about the demand for the product. If the company decides to go ahead with the project after 1 year, the company needs to invest $50 million. The risk-free rate is 5% (continuously compounded). What is the value of the option to delay (in $ million)?arrow_forward
- You are considering opening a new plant. The plant will cost $100.0 million upfront. After that, it is expected to produce profits of $30.0 million at the end of every year. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 8.0%. Should you make the investment? Calculate the IRR. Use the IRR to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged.arrow_forwardAriana, Incorporated, is considering a project that will result in initial aftertax cash savings of $6.1 million at the end of the first year, and these savings will grow at a rate of 3 percent per year, indefinitely. The firm has a target debt-equity ratio of .60, a cost of equity of 13 percent, and an aftertax cost of debt of 5.5 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +3 percent to the cost of capital for such risky projects. a. Calculate the required return for the project. Note: Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16. b. What is the maximum cost the company would be willing to pay for this project? Note: Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16. a. Project required return b. Maximum to pay 13.19 %arrow_forwardAriana, Incorporated, is considering a project that will result in initial aftertax cash savings of $7 million at the end of the first year, and these savings will grow at a rate of 3 percent per year, indefinitely. The firm has a target debt-equity ratio of .69, a cost of equity of 13.4 percent, and an aftertax cost of debt of 6.4 percent. The cost-saving proposal is somewhat riskier than the usual project the firm undertakes; management uses the subjective approach and applies an adjustment factor of +3 percent to the cost of capital for such risky projects.arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
Cornerstones of Cost Management (Cornerstones Ser...AccountingISBN:9781305970663Author:Don R. Hansen, Maryanne M. MowenPublisher:Cengage Learning
Principles of Accounting Volume 2AccountingISBN:9781947172609Author:OpenStaxPublisher:OpenStax College
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Cornerstones of Cost Management (Cornerstones Ser...
Accounting
ISBN:9781305970663
Author:Don R. Hansen, Maryanne M. Mowen
Publisher:Cengage Learning
Principles of Accounting Volume 2
Accounting
ISBN:9781947172609
Author:OpenStax
Publisher:OpenStax College
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