If the Rhine Company ignores the possibility that other firms may enter its market, it should set a price of $10,000 for its product, which is a power tool. But if it does so, other firms will begin to enter the market. During the next two years it will earn $4 million per year, but in the following two years it will earn $1 million per year. On the other hand, if it sets a price of $7,000, it will earn $2.5 million in each of the next four years because no entrants will appear. If the interest rate is 8 percent, should the Rhine Company set a price of $7,000 or $10,000? a. NPV $10.0M for $7,000 price b. NPV $10.0M for $10,000 price c. NPV $7.3M for $7,000 price d. NPV $8.7M for $10,000 price

If the Rhine Company ignores the possibility that other firms may enter its market, it should set a price of $10,000 for its product, which is a power tool. But if it does so, other firms will begin to enter the market. During the next two years it will earn $4 million per year, but in the following two years it will earn $1 million per year. On the other hand, if it sets a price of $7,000, it will earn $2.5 million in each of the next four years because no entrants will appear. If the interest rate is 8 percent, should the Rhine Company set a price of $7,000 or $10,000? a. NPV $10.0M for $7,000 price b. NPV $10.0M for $10,000 price c. NPV $7.3M for $7,000 price d. NPV $8.7M for $10,000 price

Intermediate Financial Management (MindTap Course List)

13th Edition

ISBN:9781337395083

Author:Eugene F. Brigham, Phillip R. Daves

Publisher:Eugene F. Brigham, Phillip R. Daves

Chapter12: Capital Budgeting: Decision Criteria

Section: Chapter Questions

Problem 17P: The Perez Company has the opportunity to invest in one of two mutually exclusive machines that will...

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Talbot Industries is considering launching a new product. The new manufacturing equipment will cost $17 million, and production and sales will require an initial $5 million investment in net operating working capital. The company’s tax rate is 25%. What is the initial investment outlay? The company spent and expensed $150,000 on research related to the new product last year. What is the initial investment outlay? Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for $1.5 million after taxes and real estate commissions. What is the initial investment outlay?
The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has an initial after-tax cost of 170,000. The project will produce 1,000 cases of mineral water per year indefinitely, starting at Year 1. The Year-1 sales price will be 138 per case, and the Year-1 cost per case will be 105. The firm is taxed at a rate of 25%. Both prices and costs are expected to rise after Year 1 at a rate of 6% per year due to inflation. The firm uses only equity, and it has a cost of capital of 15%. Assume that cash flows consist only of after-tax profits because the spring has an indefinite life and will not be depreciated. a. What is the present value of future cash flows? (Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.) What is the NPV? b. Suppose that the company had forgotten to include future inflation. What would they have incorrectly calculated as the projects NPV?
Talbot Industries is considering launching a new product. The new manufacturing equipment will cost 17 million, and production and sales will require an initial 5 million investment in net operating working capital. The companys tax rate is 40%. a. What is the initial investment outlay? b. The company spent and expensed 150,000 on research related to the new product last year. Would this change your answer? Explain. c. Rather than build a new manufacturing facility, the company plans to install the equipment in a building it owns but is not now using. The building could be sold for 1.5 million after taxes and real estate commissions. How would this affect your answer?
At Stardust Gems, a faux gem and jewelry company, the setting department is a bottleneck. The company is considering hiring an extra worker, whose salary will be $67,000 per year, to ease the problem. Using the extra worker, the company will be able to produce and sell 9,000 more units per year. The selling price per unit is $20. The cost per unit currently is $15.85 as shown: What is the annual financial impact of hiring the extra worker for the bottleneck process?
I know that its the thing to do, insisted Pamela Kincaid, vice president of finance for Colgate Manufacturing. If we are going to be competitive, we need to build this completely automated plant. Im not so sure, replied Bill Thomas, CEO of Colgate. The savings from labor reductions and increased productivity are only 4 million per year. The price tag for this factoryand its a small oneis 45 million. That gives a payback period of more than 11 years. Thats a long time to put the companys money at risk. Yeah, but youre overlooking the savings that well get from the increase in quality, interjected John Simpson, production manager. With this system, we can decrease our waste and our rework time significantly. Those savings are worth another million dollars per year. Another million will only cut the payback to about 9 years, retorted Bill. Ron, youre the marketing managerdo you have any insights? Well, there are other factors to consider, such as service quality and market share. I think that increasing our product quality and improving our delivery service will make us a lot more competitive. I know for a fact that two of our competitors have decided against automation. Thatll give us a shot at their customers, provided our product is of higher quality and we can deliver it faster. I estimate that itll increase our net cash benefits by another 2.4 million. Wow! Now thats impressive, Bill exclaimed, nearly convinced. The payback is now getting down to a reasonable level. I agree, said Pamela, but we do need to be sure that its a sound investment. I know that estimates for construction of the facility have gone as high as 48 million. I also know that the expected residual value, after the 20 years of service we expect to get, is 5 million. I think I had better see if this project can cover our 14% cost of capital. Now wait a minute, Pamela, Bill demanded. You know that I usually insist on a 20% rate of return, especially for a project of this magnitude. Required: 1. Compute the NPV of the project by using the original savings and investment figures. Calculate by using discount rates of 14% and 20%. Include salvage value in the computation. 2. Compute the NPV of the project using the additional benefits noted by the production and marketing managers. Also, use the original cost estimate of 45 million. Again, calculate for both possible discount rates. 3. Compute the NPV of the project using all estimates of cash flows, including the possible initial outlay of 48 million. Calculate by using discount rates of 14% and 20%. 4. CONCEPTUAL CONNECTION If you were making the decision, what would you do? Explain.
The J.R. Ryland Computer Company is considering a plant expansion to enable the company to begin production of a new computer product. The companys president must determine whether to make the expansion a medium- or large-scale project. Demand for the new product is uncertain, which for planning purposes may be low demand, medium demand, or high demand. The probability estimates for demand are 0.20, 0.50, and 0.30, respectively. Letting x and y indicate the annual profit in thousands of dollars, the firms planners developed the following profit forecasts for the medium-and large-scale expansion projects. a. Compute the expected value for the profit associated with the two expansion alternatives. Which decision is preferred for the objective of maximizing the expected profit? b. Compute the variance for the profit associated with the two expansion alternatives. Which decision is preferred for the objective of minimizing the risk or uncertainty?
Baghdad Company produces a single product. They have recently received the result of a market survey that indicates that they can increase the retail price of their product by 10% without losing customers or market share. All other costs will remain unchanged. If they enact the 10% price increase, what will be their new break-even point in units and dollars? Their most recent CVP analysis is:
Hemmingway, Inc. is considering a $5 million research and development (R&D) project. Profit projections appear promising, but Hemmingway’s president is concerned because the probability that the R&D project will be successful is only 0.50. Furthermore, the president knows that even if the project is successful, it will require that the company build a new production facility at a cost of $20 million in order to manufacture the product. If the facility is built, uncertainty remains about the demand and thus uncertainty about the profit that will be realized. Another option is that if the R&D project is successful, the company could sell the rights to the product for an estimated $25 million. Under this option, the company would not build the $20 million production facility. The decision tree follows. The profit projection for each outcome is shown at the end of the branches. For example, the revenue projection for the high demand outcome is $59 million. However, the cost of the R&D project ($5 million) and the cost of the production facility ($20 million) show the profit of this outcome to be $59 – $5 – $20 = $34 million. Branch probabilities are also shown for the chance events. Analyze the decision tree to determine whether the company should undertake the R&D project. If it does, and if the R&D project is successful, what should the company do? What is the expected value of your strategy? What must the selling price be for the company to consider selling the rights to the product? Develop a risk profile for the optimal strategy.
Global Reach, Inc., is considering opening a new warehouse to serve the Southwest region. Darnell Moore, controller for Global Reach, has been reading about the advantages of foreign trade zones. He wonders if locating in one would be of benefit to his company, which imports about 90 percent of its merchandise (e.g., chess sets from the Philippines, jewelry from Thailand, pottery from Mexico, etc.). Darnell estimates that the new warehouse will store imported merchandise costing about 16.78 million per year. Inventory shrinkage at the warehouse (due to breakage and mishandling) is about 8 percent of the total. The average tariff rate on these imports is 5.5 percent. Required: 1. If Global Reach locates the warehouse in a foreign trade zone, how much will be saved in tariffs? Why? (Round your answer to the nearest dollar.) 2. Suppose that, on average, the merchandise stays in a Global Reach warehouse for nine months before shipment to retailers. Carrying cost for Global Reach is 6 percent per year. If Global Reach locates the warehouse in a foreign trade zone, how much will be saved in carrying costs? What will the total tariff-related savings be? (Round your answers to the nearest dollar.) 3. Suppose that the shifting economic situation leads to a new tariff rate of 13 percent, and a new carrying cost of 6.5 percent per year. To combat these increases, Global Reach has instituted a total quality program emphasizing reducing shrinkage. The new shrinkage rate is 7 percent. Given this new information, if Global Reach locates the warehouse in a foreign trade zone, how much will be saved in carrying costs? What will the total tariff-related savings be? (Round your answers to the nearest dollar.)
Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows: The system will cost 9,000,000 and last 10 years. The companys cost of capital is 12 percent. Required: 1. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? 2. Calculate the NPV and IRR for the project. Should the system be purchasedeven if it does not meet the payback criterion? 3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of 1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of 300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Does the decision change? Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does salvage value have any real bearing on the companys decision?
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