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Chapter 31, Problem 13P

Assume that in the original Ityesi example in Table 31.1, all sales actually occur in the United States and are projected to be $60 million per year for four years. Keeping the cost of sales, operating expenses, capital expenditures and depreciation expenses unchanged (and in pounds), and assuming the tax rate remains at 40%, calculate the NPV of the investment opportunity.

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Scenario one: Under what circumstances would it be appropriate for a firm to use different cost of capital for its different operating divisions? If the overall firm WACC was used as the hurdle rate for all divisions, would the riskier division or the more conservative divisions tend to get most of the investment projects? Why? If you were to try to estimate the appropriate cost of capital for different divisions, what problems might you encounter? What are two techniques you could use to develop a rough estimate for each division’s cost of capital?
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