Fundamentals of Financial Management (MindTap Course List)
15th Edition
ISBN: 9781337671002
Author: Brigham
Publisher: Cengage
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Chapter 13, Problem 3P
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To discuss: The action that the Person X recommended to the AT Company.
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All American Telephones Inc. is considering the production of a new cell phone. The project will require an investment of $13 million. If the phone is well received, the project will produce cash flows of $8 million a year for 3 years, but if the market does not like the product, the cash flows will be only $1 million per year. There is a 50% probability of both good and bad market conditions. All American can delay the project a year while it conducts a test to determine whether demand will be strong or weak. The delay will not affect the dollar amounts involved for the project’s investment or its cash flows—only their timing. Because of the anticipated shifts in technology, the 1-year delay means that cash flows will continue only 2 years after the initial investment is made. All American’s WACC is 10%. The data has been collected in the Microsoft Excel Online file below. Open the spreadsheet and perform the required analysis to answer the question below.
Open spreadsheet…
All American Telephones Inc. is considering the production of a new cell phone. The project will require an investment of $13 million. If the phone is well received, the project will produce cash flows of $8 million a year for 3 years, but if the market does not like the product, the cash flows will be only $1 million per year. There is a 50% probability of both good and bad market conditions. All American can delay the project a year while it conducts a test to determine whether demand will be strong or weak. The delay will not affect the dollar amounts involved for the project's investment or its cash flows-only their timing. Because of the anticipated shifts in technology, the 1-year delay means that cash flows will continue only 2 years after the initial investment is made. All American's WACC is 9%.
What's the NPV without waiting?
What's the NPV of waiting 1 year?
All American Telephones Inc. is considering the productionof a new cell phone. The project will require an investment of $13 million. If the phone iswell received, the project will produce cash flows of $8 million a year for 3 years, but ifthe market does not like the product, the cash flows will be only $2 million per year. Thereis a 50% probability of both good and bad market conditions. All American can delay theproject a year while it conducts a test to determine whether demand will be strong or weak.The delay will not affect the dollar amounts involved for the project’s investment or its cashflows—only their timing. Because of the anticipated shifts in technology, the 1-year delaymeans that cash flows will continue only 2 years after the initial investment is made. AllAmerican’s WACC is 8%. What action do you recommend?
Chapter 13 Solutions
Fundamentals of Financial Management (MindTap Course List)
Ch. 13 - Explain in general terms what each of the...Ch. 13 - Would a failure to recognize growth options tend...Ch. 13 - Companies often have to increase their initial...Ch. 13 - How might a firms corporate WACC be affected by...Ch. 13 - Prob. 5QCh. 13 - GROWTH OPTION Singh Development Co. is deciding...Ch. 13 - OPTIMAL CAPITAL BUDGET Marble Construction...Ch. 13 - Prob. 3PCh. 13 - ABANDONMENT OPTION The Scampini Supplies Company...Ch. 13 - OPTIMAL CAPITAL BUDGET Hampton Manufacturing...
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