Financial Management: Theory & Practice
Financial Management: Theory & Practice
16th Edition
ISBN: 9780357296776
Author: Eugene F. Brigham, Michael C. Ehrhardt
Publisher: Cengage Learning US
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Chapter 11, Problem 8P

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.

  1. 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?
  2. b. Suppose that the company had forgotten to include future inflation. What would they have incorrectly calculated as the project’s NPV?
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The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has an initial after-tax cost of $140,000. The project will produce 800 cases of mineral water per year indefinitely, starting at Year 1. The Year-1 sales price will be $133 per case, and the Year-1 cost per case will be $106. The firm is taxed at a rate of 25%. Both prices and costs are expected to rise after Year 1 at a rate of 4% 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. 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? Do not round intermediate calculations. Round your answers to the nearest dollar. Negative values, if any, should be indicated by a minus sign. PV of future CFs: $ NPV: $…
A start-up biotech company is considering making an investment of $100,000 in a new filtration system. The associated estimates are summarized as shown below: Straight-line depreciation will be used, and the effective income tax rate is 20%. The after-tax MARR is 15% per year. Determine whether this investment is an attractive option for the company.
Your firm is considering a project that would cost $325,000 and be depreciated straight-line over four years to $0 book value. Your firm estimates $15,000 in yearly after-tax operating costs. The required return is 12.0 percent, and the firm pays a 21.0 percent tax rate. What is the equivalent annual cost of this project?

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Financial Management: Theory & Practice

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