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Chapter 9, Problem 1OR

In the chapter opener you learned that Johnson & Johnson’s weighted average cost of capital was around 6% but its investments were earning returns closer to 17%. In 2016, J&J invested about $3.2 billion in capital expenditures. Suppose J&J spends the same amount this year to expand its manufacturing facilities, and that investment produces a net cash flow of $544 million (17% of $3.2 billion) every year in perpetuity. Calculate the NPV of that investment using a 6% discount rate. How much value does the $3.2 billion investment create or destroy? Does it seem that J&J should be pursuing growth in this market?

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Summary Introduction

To discuss:

To calculate the NPV.

Introduction:

The difference among the present value of cash inflows and the present value of cash outflows for a period of time is known as the Net Present value. NPV is utilized in capital budgeting as a criterion to analyze the profitability of projects.

Explanation of Solution

The NPV can be calculated as follows,

NPV1 year=Net cash flowDiscount rate=5440.06=9,066.67

Since the NPV value is positive the projects creates a value worth $9,066.67 million.

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Chapter 9 Solutions

Principles of Managerial Finance, Student Value Edition Plus MyLab Finance with Pearson eText - Access Card Package (15th Edition) (Pearson Series in Finance)

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