EBK CORPORATE FINANCE
4th Edition
ISBN: 8220103164535
Author: DeMarzo
Publisher: PEARSON
expand_more
expand_more
format_list_bulleted
Concept explainers
Question
Chapter 22, Problem 13P
Summary Introduction
To determine: The current value of the project.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solutionStudents have asked these similar questions
Parasite Engineering is developing a new product for the parasitic market that services parasites. The opportunity is estimated to be worth $1.0B measured in today’s dollars. The company will need to spend $500M today to begin the research. In five years, the company will have to make a decision as to whether to go into full scale production and begin selling the drug. At that time, the company estimates it will cost $1.5B to move forward. If the appropriate risk-free rate is 2.5%, how high must the annual volatility be to make the project worth beginning?
Finozest Solutions is considering setting up a facility to manufacture computers. The manufacturing facility will cost K15 million to build and will have the capacity to sell 50,000 computers a year. Each computer is expected to sell retail for K2,800, and the cost of making each computer is expected to be K1,400. The fixed costs amount to K150,000 per year are expected to be incurred. The business will run for five years, at which time you estimate the market value of the facility to be zero. The discount rate is estimated at 10%, and the tax rate is 40%.
(a) Estimate the accounting rate of return expected from his investment.
(b) Using the net present value technique for project evaluation, advise Finozest solutions on whether they should undertake this project.
(c) After the release of the latest GDP projections for the country, you now estimate that at the end of 5 years, you could sell the facility for K5 million. Estimate the breakeven rate for the project.
You are considering investing in a project related to a new product opportunity. If you undertake the project immediately, you calculate the NPV will be $165,000. If you postpone the decision for one year, you will learn more about the relevant manufacturing process as well as the market for your product. If you wait one year, you expect with 80 percent likelihood competitors will enter the market and your NPV (in one year) will be - $20,000. With 20 percent likelihood, you will be the only market player and you will improve your production technology to create an NPV (in one year) of $400,000. The appropriate discount rate is 11 percent.
Required:
Calculate the expected NPV if you defer the project for one year, regardless of the potential scenario.
Calculate the expected NPV if you strategically decide how to undertake your project. That is, if we find that competitors enter the market, we can decide not to enter.
Interpret the difference in your answers to parts 1 and 2.
Chapter 22 Solutions
EBK CORPORATE FINANCE
Ch. 22.1 - What is the difference between a real option and a...Ch. 22.1 - Why does a real option add value to an investment...Ch. 22.2 - Prob. 1CCCh. 22.2 - In what circumstances does the real option add...Ch. 22.2 - How do you use a decision tree to make the best...Ch. 22.3 - What is the economic trade-off between investing...Ch. 22.3 - Prob. 2CCCh. 22.3 - Does an option to invest have the same beta as the...Ch. 22.4 - Why can a firm with no ongoing projects, and...Ch. 22.4 - Why is it sometimes optimal to invest in stages?
Ch. 22.4 - How can an abandonment option add value to a...Ch. 22.5 - Prob. 1CCCh. 22.5 - Prob. 2CCCh. 22.6 - Why can staging investment decisions add value?Ch. 22.6 - How can you decide the order of investment in a...Ch. 22.7 - Prob. 1CCCh. 22.7 - Prob. 2CCCh. 22 - Your company is planning on opening an office in...Ch. 22 - You are trying to decide whether to make an...Ch. 22 - Prob. 4PCh. 22 - Prob. 5PCh. 22 - You are a financial analyst at Global Conglomerate...Ch. 22 - Prob. 7PCh. 22 - Prob. 8PCh. 22 - Consider again the electric car dealership in...Ch. 22 - Prob. 12PCh. 22 - Prob. 13PCh. 22 - You are an analyst working for Goldman Sachs, and...Ch. 22 - You own a small networking startup. You have just...Ch. 22 - An original silver dollar from the late eighteenth...Ch. 22 - What implicit assumption is made when managers use...Ch. 22 - Prob. 22PCh. 22 - Genenco is developing a new drug that will slow...Ch. 22 - Prob. 24PCh. 22 - Your firm is thinking of expanding. If you invest...Ch. 22 - Prob. 26PCh. 22 - Assume that the project in Example 22.5 pays an...
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
- The scientist of spectrum have come up with an electric mop. The firm is ready for pilot production and test marketing.This will cost tk 20 million and take six months. Management believes that there is 70% chance that the pilot production and test market will be successful. In case of success, spectrum can build a plant costing tk 150 million. The plant will generate an annual cash flow of tk 30 million for 20 years if demand is high and 20 million if demand is low. High demand has probability of .6 ; low demand has a probability of 0.4. what is the optimal course of action using decision tree analysis? Assume discount rate is 12%.arrow_forwardA company that manufactures high-strength epoxys is considering investing $100,000 in two new adhesives identified as X and Z. The investment in X is $20,000 and is expected to yield a rate of return of 40% per year. Your supervisor asked you to determine what rate of return would be required on the remaining $80,000 in order for the total return to be at least 25%. You responded that the return would have to be at least: (a) 10.4% (b) 16.8% (c) 21.3% (d) 24.1%arrow_forwardImperial Motors is considering producing its popular Rooster model in China. This will involve an initial investment of CNY 5.3 billion. The plant will start production after one year. It is expected to last for five years and have a salvage value at the end of this period of CNY 513 million in real terms. The plant will produce 100,000 cars a year. The firm anticipates that in the first year, it will be able to sell each car for CNY 78,000, and thereafter the price is expected to increase by 4% a year. Raw materials for each car are forecasted to cost CNY 31,000 in the first year, and these costs are predicted to increase by 3% annually. Total labor costs for the plant are expected to be CNY 2.4 billion in the first year and thereafter will increase by 7% a year. The land on which the plant is built can be rented for five years at a fixed cost of CNY 313 million a year payable at the beginning of each year. Imperial’s discount rate for this type of project is 10% (nominal). The…arrow_forward
- The plant manager of IHK is considering the purchase of a new robotic assemble plant. The new robotic line will cost $250,000. The manager believes that the new investment will result in direct labor savings of $62,500 per year for ten years.Requirements:a. What is the payback period for this projectb. What is the net present value or PV assuming a 10% rate of return?c. Should the plant manager accept or reject the project?d. What else should the manager consider in the analysis?arrow_forwardGenz has come up with a new product prototype and is ready to go ahead with pilot production and test marketing. The pilot pro- duction and test marketing phase will last for one year and cost $500,000. Your management team believes that there is a 50% chance that the test marketing will be successful and that there will be sufficient demand for the new product. If the test-marketing phase is successful, then GenZ will invest $3 million in year one to build a plant that will generate expected annual after tax cash flows of $400,000 in perpetuity beginning in year two. If the test mar- keting is not successful, Genz can still go ahead and build the new plant, but the expected annual after tax cash flows would be only $200,000 in perpetuity beginning in year two. GenZ has the option to stop the project at any time and sell the prototype product to an overseas competitor for $300,000. GenZ's cost of capital is 10%. a) Assuming that GenZ has the ability to sell the prototype in year one…arrow_forwardDeep Drill Inc. is evaluating a project to produce a high-tech deep-sea oil exploration device. The investment required is $80 million for a plant with a capacity of 15,000 units a year for 5 years. The device will be sold for a price of $12,000 per unit. Sales are expected to be 12,000 units per year. The variable cost is $7,000 and fixed costs, excluding depreciation, are $25 million per year. Assume Deep Drill employs straight-line depreciation on all depreciable assets, and assume that they are taxed at a rate of 36%. If the required rate of return is 12%, what is the approximate NPV of the project?arrow_forward
- FastTrack Bikes, Inc. is thinking of developing a new composite road bike. Development will take six years and the cost is $176,000 per year. Once in production, the bike is expected to make $281,600 per year for 10 years. Assume the cost of capital is 10%. Calculate the NPV of this investment opportunity, assuming all cash flows occur at the end of each year. Should the company make the investment? The present value of the costs is how much(Round to the nearestdollar.) By how much must the cost of capital estimate deviate to change the decision? (Hint: Use Excel to calculate the IRR.) What is the NPV of the investment if the cost of capital is 15%? (Round to two decimal places) Note: Assume that all cash flows occur at the end of the appropriate year and that the inflows do not start until year 7.arrow_forwardAnsarrow_forwardTurik Electronics manufactures microprocessorbased soft starters that use thyristors for controlled reduced voltage during starting and stopping. The company is planning a production-line expansion that will cost $1.3 million. If the company uses a minimum attractive rate of return of 15% per year, what is the equivalent annual cost in years 1 through 5 of the investment?arrow_forward
- A company that manufactures high-strength epoxys is considering investing $100,000 in two new adhesives identified as X and Z. The investment in X is $20,000 and is expected to yield a rate of return of 40% per year. Your supervisor asked you to determine what rate of return would be required on the remaining $80,000 in order for the total return to be at least 25%. You responded that the return would have to be at least Multiple Choice O O 10.4% 16.8% 21.3% 24.1%arrow_forwardYou have developed the technology to use gold to produce high capacity fiber optic switches. The technology has cost $ 5 million to develop. You need $50 million of initial capital investment to start production. Sales of the switch sales will be $20 million per year for the next 5 years and then drop to zero. The main cost of production is gold. Each year, you need 20,000 ounces of gold. Gold is currently selling for $250 per ounce. Your supplier thinks that the gold price will appreciated at 5% per year for the next 5 years. The cost of capital is 10% for the fiber-optics business. The tax rate is 35%. The capital investment can be depreciated linearly over the next 5 years. Calculate the after-tax cash flows of the project Should you take the project?arrow_forwardPCM Thermal Products uses austenitic nickelchromium alloys to manufacture resistance heating wire. The company is considering a new annealing-drawing process to reduce costs. If the new process will cost $3.25 million dollars now, how much must be saved each year to recover the investment in 6 years at an interest rate of 15% per year?arrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
- Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
- Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage LearningCorporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education
Essentials Of Investments
Finance
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Mcgraw-hill Education,
Foundations Of Finance
Finance
ISBN:9780134897264
Author:KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher:Pearson,
Fundamentals of Financial Management (MindTap Cou...
Finance
ISBN:9781337395250
Author:Eugene F. Brigham, Joel F. Houston
Publisher:Cengage Learning
Corporate Finance (The Mcgraw-hill/Irwin Series i...
Finance
ISBN:9780077861759
Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan Professor
Publisher:McGraw-Hill Education
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