PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Textbook Question
Chapter 6, Problem 2PS
Cash flows Reliable Electric, a major Ruritanian producer of electrical products, is considering a proposal to manufacture a new type of industrial electric motor that would replace most of its existing product line. A research breakthrough has given Reliable a two-year lead on its competitors. The project proposal is summarized in Table 6.4.
- a. Read the notes to the table carefully. Which entries make sense? Which do not? Why or why not?
- b. What additional information would you need to construct a version of Table 6.4 that makes sense?
Construct such a table and recalculate NPV. Make additional assumptions as necessary.
TABLE 6.4 Cash flows and
Notes:
1. Capital expenditure: $8 million for new machinery and $2.4 million for a warehouse extension. The full cost of the extension has been charged to this project, although only about half of the space is currently needed. Since the new machinery will be housed in an existing factory building, no charge has been made for land and building.
2. Research and development: $1.82 million spent in 2017. This figure was corrected for 10% inflation from the time of expenditure to date. Thus 1.82 × 1.1 = $2 million.
3. Working capital: Initial investment in inventories.
4. Revenue: These figures assume sales of 2,000 motors in 2019, 4,000 in 2020, and 10,000 per year from 2021 through 2028. The Initial unit price of $4,000 is
5. Operating costs: These include all direct and indirect costs. Indirect costs (heat, light, power,
6. Overhead: Marketing and administrative costs, assumed equal to 10% of revenue.
7.
8. Interest: Charged on capital expenditure and working capital at Reliable’s current borrowing rate of 15%.
9. Income: Revenue less the sum of research and development, operating costs, overhead, depreciation, and interest.
10. Tax: 30% of income. However, income is negative in 2018. This loss is carried forward and deducted from taxable income in 2020.
11. Net cash flow: Assumed equal to income less tax.
12.
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Question 1
You recently went to work for Ndejiku Company, a supplier of auto repair parts used in the after-market with products from Daimler, Chrysler, Ford, and other automakers. Your boss, the chief financial officer (CFO), has just handed you the estimated cash flows for two proposed projects. Project X involves adding a new item to the firm’s ignition system line. Project Y involves an add-on to an existing line, and its cash flows would decrease over time. Both projects have 4-year lives. Here are the projects’ net cash flows (in thousands of kwachas):
Year
0
1
2
3
4
Project X
-110,000
10,000
60,000
80,000
90,000
Project Y
-110,000
90,000
60,000
30,000
10,000
If Ndejiku’s cost of capital is 10%. Advise whether one or both of the projects should be accepted using:
Payback period method if
Projects are mutually exclusive
Projects are Independent of each other
Net Present Value (NPV) if projects are independent of each other
Nirvana Chip Designs has finished designing its next generation of chips, the XJ5000 series and is getting ready to start production. As the analyst on the project, you are required to prepare pro forma free cash flows. Which of the following are relevant to your analysis?
Design cost for the chips
Potential lost sales of the XJ4000 chips
Proportional cost of the corporate jet lease
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Upgrades to the chip fabrication facility required if the chip is produced
Market research done to guide the development of the new chip
Market value of land and buildings where new chip will be produced
Design cost for the chips. (Select the best choice below.)
A.
This is relevant because it is an investment in working capital.
B.
This is relevant as it represents cannibalization of existing sales.
C.
This is irrelevant because it is a sunk cost.
D.
This is irrelevant as it represents existing overhead.
b. Potential lost sales…
Chapter 6 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 6 - Cash flows Which of the following should be...Ch. 6 - Cash flows Reliable Electric, a major Ruritanian...Ch. 6 - Prob. 3PSCh. 6 - Prob. 4PSCh. 6 - Real and nominal flows Mr. Art Deco will be paid...Ch. 6 - Real and nominal flows Restate the net cash flows...Ch. 6 - Real and nominal flows Guandong Machinery is...Ch. 6 - Working capital Each of the following statements...Ch. 6 - Prob. 9PSCh. 6 - Project NPV Better Mousetraps research...
Ch. 6 - Project NPV A widget manufacturer currently...Ch. 6 - Project NPV Marsha Jones has bought a used...Ch. 6 - Project NPV United Pigpen is considering a...Ch. 6 - Project NPV Imperial Motors is considering...Ch. 6 - Project NPV and IRR A project requires an initial...Ch. 6 - Taxes and project NPV In the International Mulch...Ch. 6 - Depreciation and project NPV Suppose that Sudbury...Ch. 6 - Depreciation and project NPV Ms. T. Potts, the...Ch. 6 - Prob. 20PSCh. 6 - Prob. 21PSCh. 6 - Prob. 22PSCh. 6 - Equivalent annual cash flow Look at Problem 22...Ch. 6 - Equivalent annual cash flow Deutsche Transport can...Ch. 6 - Prob. 25PSCh. 6 - Mutually exclusive investments and project lives...Ch. 6 - Mutually exclusive investments and project lives...Ch. 6 - Mutually exclusive investments and project lives....Ch. 6 - Mutually exclusive investments and project lives...Ch. 6 - Mutually exclusive investments and project lives...Ch. 6 - Replacement decisions Machine C was purchased five...Ch. 6 - Replacement decisions Hayden Inc. has a number of...Ch. 6 - Replacement decisions. You are operating an old...Ch. 6 - Replacement decisions. A forklift will last for...Ch. 6 - The cost of excess capacity The presidents...Ch. 6 - Effective tax rates One measure of the effective...Ch. 6 - Equivalent annual costs We warned that equivalent...
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