Concept explainers
Libby Flannery, the regional manager of Ecsy-Cola, the international soft drinks empire, was reviewing her investment plans for Central Asia. She had contemplated launching Ecsy-Cola in the ex-Soviet republic of Inglistan in 2022. This would involve a capital outlay of $20 million in 2021 to build a bottling plant and set up a distribution system there. Fixed costs (for manufacturing, distribution, and marketing) would then be $3 million per year from 2021 onward. This would be sufficient to make and sell 200 million liters per year—enough for every man, woman, and child in Inglistan to drink four bottles per week! But there would be few savings from building a smaller plant, and import tariffs and transport costs in the region would keep all production within national borders.
The variable costs of production and distribution would be 12 cents per liter. Company policy requires a
Bottling plants last almost forever, and all unit costs and revenues were expected to remain constant in nominal terms. Tax would be payable at a rate of 30%, and under the Inglistan corporate tax code, capital expenditures can be written off on a straight-line basis over four years.
All these inputs were reasonably clear. But Ms. Flannery racked her brain trying to
Ms. Flannery also worried whether it would be better to wait a year. The soft drink market was developing rapidly in neighboring countries, and in a year’s time she should have a much better idea whether Ecsy-Cola would be likely to catch on in Inglistan. If it didn’t catch on and sales stalled below 20 million liters, a large investment probably would not be justified.
Ms. Flannery had assumed that Ecsy-Cola’s keen rival, Sparky-Cola, would not also enter the market. But last week she received a shock when in the lobby of the Kapitaliste Hotel she bumped into her opposite number at Sparky-Cola. Sparky-Cola would face costs similar to Ecsy-Cola. How would Sparky-Cola respond if Ecsy-Cola entered the market? Would it decide to enter also? If so, how would that affect the profitability of Ecsy-Cola’s project?
Ms. Flannery thought again about postponing investment for a year. Suppose Sparky-Cola were interested in the Inglistan market. Would that favor delay or immediate action?
Maybe Ecsy-Cola should announce its plans before Sparky-Cola has a chance to develop its own proposals. It seemed that the Inglistan project was becoming more complicated by the day.
What are the pros and cons of waiting for a year before deciding whether to invest? (Hint: What happens if demand turns out high and Sparky-Cola also invests? What if Ecsy-Cola invests right away and gains a one-year head start on Sparky-Cola?)
Want to see the full answer?
Check out a sample textbook solutionChapter 11 Solutions
Principles of Corporate Finance
- OpenDoor Cafe is considering opening a new food court in a major US city. The initial investment is expected to be $ 12,550,000. The projected cash flows are $4, 955,000 in years one and two, $2, 185,000 in year three, $2,715,000 in year four, and $3,040,000 on year five. What is this project's internal rate of return? Group of answer choices 6.70% 17.26 % 11.28% 15.02%arrow_forwardMicheal’s Machinery is a German multinational manufacturing company. Currently, Micheal’s financial planners are considering undertaking a 1-year project in the United States. The project's expected dollar-denominated cash flows consist of an initial investment of $2000 and a cash inflow the following year of $2400. Micheal’s estimates that its risk-adjusted cost of capital is 12%. Currently, 1 U.S. dollar will buy 0.7 Germany. In addition, 1-year risk-free securities in the United States are yielding 6.5%, while similar securities in Germany’s are yielding 4.5%. If this project was instead undertaken by a similar U.S.-based company with the same risk-adjusted cost of capital, what would be the net present value and rate of return generated by this project? Round your answers to two decimal places. What is the expected forward exchange rate 1 year from now? Round your answer to two decimal places. If Micheal undertakes the project, what is the net present value and rate of return of…arrow_forwardThe Houston American Cement factory will require an investment of $200 million to construct. Delays beyond the anticipated implementation year of 2012 will require additional money to construct the factory. Assuming that the cost of money is 10% per year, compound interest. Determine the following for the board of directors of the Brazilian company that plans to develop the plant. (a) The equivalent investment needed if the plant is built in 2015. (b) The equivalent investment needed had the plant been constructed in the year 2008.arrow_forward
- Imperial Motors is considering producing its popular Rooster model in China. This will involve an initial investment of CNY 4.9 billion. The plant will start production after one year. It is expected to last for five years and have a salvage value at the end of this period of CNY 509 million in real terms. The plant will produce 100,000 cars a year. The firm anticipates that in the first year, it will be able to sell each car for CNY 74,000, and thereafter the price is expected to increase by 4% a year. Raw materials for each car are forecasted to cost CNY 27,000 in the first year, and these costs are predicted to increase by 3% annually. Total labor costs for the plant are expected to be CNY 2.0 billion in the first year and thereafter will increase by 7% a year. The land on which the plant is built can be rented for five years at a fixed cost of CNY 309 million a year payable at the beginning of each year. Imperial's discount rate for this type of project is 10% (nominal). The…arrow_forwardImperial Motors is considering producing its popular Rooster model in China. This will involve an initial investment of CNY 4.1 billion. The plant will start production after one year. It is expected to last for five years and have a salvage value at the end of this period of CNY 501 million in real terms. The plant will produce 200,000 cars a year. The firm anticipates that in the first year, it will be able to sell each car for CNY 66,000, and thereafter the price is expected to increase by 4% a year. Raw materials for each car are forecasted to cost CNY 19,000 in the first year, and these costs are predicted to increase by 3% annually. Total labor costs for the plant are expected to be CNY 1.2 billion in the first year and thereafter will increase by 7% a year. The land on which the plant is built can be rented for five years at a fixed cost of CNY 301 million a year payable at the beginning of each year. Imperial's discount rate for this type of project is 14% (nominal). The…arrow_forwardImperial Motors is considering producing its popular Rooster model in China. This will involve an initial investment of CNY 5.3 billion. The plant will start production after one year. It is expected to last for five years and have a salvage value at the end of this period of CNY 513 million in real terms. The plant will produce 100,000 cars a year. The firm anticipates that in the first year, it will be able to sell each car for CNY 78,000, and thereafter the price is expected to increase by 4% a year. Raw materials for each car are forecasted to cost CNY 31,000 in the first year, and these costs are predicted to increase by 3% annually. Total labor costs for the plant are expected to be CNY 2.4 billion in the first year and thereafter will increase by 7% a year. The land on which the plant is built can be rented for five years at a fixed cost of CNY 313 million a year payable at the beginning of each year. Imperial’s discount rate for this type of project is 10% (nominal). The…arrow_forward
- Kim Hotels is interested in developing a new hotel in Seoul. The company estimates that the hotel would require an initial investment of $20 million. Kim expects that the hotel will produce positive cash flows of $3 million a year at the end of each of the next 20 years. The project's cost of capital is 13%. While Kim expects the cash flows to be $3 million a year, it recognizes that the cash flows could, in fact, be much higher or lower, depending on whether the Korean government imposes a large hotel tax. One year from now, Kim will know whether the tax will be imposed. There is a 50% chance that the tax will be imposed, in which case the yearly cash flows will be only $2.2 million. At the same time, there is a 50% chance that the tax will not be imposed, in which case the yearly cash flows will be $3.8 million. Kim is deciding whether to proceed with the hotel today or to wait 1 year to find out whether the tax will be imposed. If Kim waits a year, the initial investment will remain…arrow_forwardSandrine Machinery is a Swiss multinational manufacturingcompany. Currently, Sandrine’s financial planners are considering undertaking a 1-yearproject in the United States. The project’s expected dollar-denominated cash flows consistof an initial investment of $2,000 and a cash inflow the following year of $2,400. Sandrineestimates that its risk-adjusted cost of capital is 10%. Currently, 1 U.S. dollar will buy0.96 Swiss franc. In addition, 1-year risk-free securities in the United States are yielding3%, while similar securities in Switzerland are yielding 1.50%.a. If this project was instead undertaken by a similar U.S.-based company with the samerisk-adjusted cost of capital, what would be the net present value and rate of returngenerated by this project?b. What is the expected forward exchange rate 1 year from now?c. If Sandrine undertakes the project, what is the net present value and rate of return ofthe project for Sandrine?arrow_forwardSuppose the multinational Milton Asset Extraction (MAX) is considering an overseas project in a country with substantial political risk. MAX predicts that the project will yield USD100 million each year for two years. The initial cost of the project is USD145 million. In any given year there is a 13% chance that the project will be expropriated by the host country’s government. The discount rate for the project is 8%. Calculate the expected net presentarrow_forward
- Sandrine Machinery is a Swiss multinational manufacturing company. Currently, Sandrine's financial planners are considering undertaking a 1-year project in the United States. The project's expected dollar denominated cash flows consist of initial investment of $2,000 and a cash inflow the year of $2,400. Sandrine estimates that its risk-adjusted cost of capital is 10%. Currently, 1 US dollar will buy 0.91 Swiss franc. In addition, 1 year risk free securities in the US are yielding 3% while similar securities in Switzerland are yielding 1.50% a) If this project was instead undertaken by a similar U.S. based company with the same risk-adjusted cost of capital what would be the net present value and rate of return generated by this project?arrow_forwardThe CFO of Expansion Group Ltd. has been presented with an opportunity to undertake a 7-year project in Turkey. As an emerging market, some incentives are available for foreign direct investment (FDI) in the country and she would like to evaluate this proposal.The following data is available for the evaluation of the project: The project investment is expected to cost £3,500,000, payable at the start of the project. Of this amount, £3,000,000 is a capital investment, with the remainder required for set up costs and other project related expenses. (Ignore depreciation for the purpose of this exercise.)The after-tax cash inflows have been estimated at £800,000 per year for the duration of the project. An opportunity cost of expansion in the UK has been identified and valued at £725,000.Costs for a visit to Turkey to evaluate the location and for meetings with the Turkish investment authority (ISPAT) have been recorded as £50,000.The company is publicly traded and the βeta of its stock is…arrow_forwardHilton Hotels is very interested in developing a new hotel in Zambia. The company estimates that the hotel would need an initial investment of $20 million. Hilton Hotel expects the hotel will generate positive cash flows of $3 million a year at the end of each of the next 20 years. The project's cost of capital is 13%. i.What is the project's net present value? ii. Hilton Hotel expects the cash flows to be $3 million a year, but it recognizes that the cash flows could actually be much higher or lower, depending on whether the Zambia government imposes a large hotel tax. One year from now, Hilton Hotel will know whether the tax will be imposed. There is a 50% chance that the tax will be imposed, in which case the yearly cash flows will be only $2.2 million. At the same time, there is a 50% chance that the tax will not be imposed, in which case the yearly cash flows will be $3.8 million. Hilton Hotel is deciding whether to proceed with the hotel today or to wait a year to find out…arrow_forward
- Essentials Of InvestmentsFinanceISBN:9781260013924Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.Publisher:Mcgraw-hill Education,
- Foundations Of FinanceFinanceISBN:9780134897264Author:KEOWN, Arthur J., Martin, John D., PETTY, J. WilliamPublisher:Pearson,Fundamentals of Financial Management (MindTap Cou...FinanceISBN:9781337395250Author:Eugene F. Brigham, Joel F. HoustonPublisher:Cengage LearningCorporate Finance (The Mcgraw-hill/Irwin Series i...FinanceISBN:9780077861759Author:Stephen A. Ross Franco Modigliani Professor of Financial Economics Professor, Randolph W Westerfield Robert R. Dockson Deans Chair in Bus. Admin., Jeffrey Jaffe, Bradford D Jordan ProfessorPublisher:McGraw-Hill Education