Corporate Finance Plus MyLab Finance with Pearson eText -- Access Card Package (4th Edition) (Berk, DeMarzo & Harford, The Corporate Finance Series)
4th Edition
ISBN: 9780134408897
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
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Chapter 22, Problem 13P
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To determine: The current value of the project.
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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.
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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
Corporate Finance Plus MyLab Finance with Pearson eText -- Access Card Package (4th Edition) (Berk, DeMarzo & Harford, The Corporate Finance Series)
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...
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