Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
4th Edition
ISBN: 9780134083278
Author: Jonathan Berk, Peter DeMarzo
Publisher: PEARSON
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Chapter 22, Problem 2P
You are trying to decide whether to make an investment of $500 million in a new technology to produce Everlasting Gobstoppers. There is a 60% chance that the market for these candies will produce profits of $100 million annually, a 20% chance the market will produce profits of $50 million, and a 20% chance that there will be no profits. The size of the market will become clear one year from now. Currently, the cost of capital of the project is 11% per year. There is a 20% chance that the cost of capital will drop to 9% in a year and stay at that level forever, and an 80% chance that it will stay at 11% forever. Movements in the cost of capital are unrelated to the size of the candy market. Construct the decision tree that shows the choices you have to make the investment either today or one year from now.
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You are trying to decide whether to make an investment of $500 million in a new technology to produce Everlasting Gobstoppers. There is 60% chance that the market for these candies will produce profits of $100 million annually in perpetuity, and a 40% chance that the market will produce profits of only $20 million per year in perpetuity. The size of the market will become clear one year from now. Assume the cost of investment is the same this year or next year and the cost of capital of this project is 10% p.a..
The value of the option to wait is around:
a.
$400 million
b.
$0 million
c.
$36 million
d.
$93 million
e.
None of the above
You are considering opening a new plant. The plant will cost $100.7 million upfront and will take one year to build.
After that, it is expected to produce profits of $28.6 million at the end of every year of production. The cash flows are
expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 6.3%. Should you
make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule?
Here is the cash flow timeline for this problem:
Years
0
2
+
28.6
3
28.6
4
+
28.6
Cash Flow ($ million) - 100.7
Calculate the NPV of this investment opportunity if your cost of capital is 6.3%.
The NPV of this investment opportunity is $ million. (Round to two decimal places.)
Forever
28.6
You are considering opening a new plant. The plant will cost $96.2 million upfront and will take one year to build. After that, it is expected to produce profits of $30.8
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
8.3%. Should you make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule?
(...)
Calculate the NPV of this investment opportunity if your cost of capital is 8.3%.
The NPV of this investment opportunity is $ 246.44 million. (Round to two decimal places.)
Should you make the investment? (Select the best choice below.)
O A. Yes, because the project will generate cash flows forever.
B. Yes, because the NPV is positive.
C. No, because the NPV is less than zero.
D. No, because the NPV is not greater than the initial costs.
Calculate the IRR.
The IRR of the project is%. (Round to two decimal places.)
Chapter 22 Solutions
Corporate Finance (4th Edition) (Pearson Series in Finance) - Standalone book
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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