Concept explainers
a.
To determine: NPV (
Introduction: The net present value helps to an organization for taking decisions regarding the growth of investment and the business. It analyzes the profitability of the project through capital budgeting.
a.
Answer to Problem 8PS
$18,092,131.90 is the Net Present Value
Explanation of Solution
Given Information:
The beta value, risk free rate of interest, expected return on market is given.
Net present value is the discounting of present value of
Calculation of net Present Value,
“C” refers to the cash flow,
“I” refers to discount rate
“t” refers to the time for cash flow
The
Calculating the NPV of the project,
So the Net Present Value is $18,092,131.90
b.
To determine: The highest possible beta for the project
Introduction: The net present value helps to an organization for taking decisions regarding the growth of investment and the business. It analyzes the profitability of the project through capital budgeting.
b.
Answer to Problem 8PS
3.47 is the highest possible value of beta for the project.
Explanation of Solution
Given Information:
The risk free rate of interest, expected return on market is given.
Net present value is the discounting of present value of cash inflow and outflow at a specified rate. When the NPV becomes positive, then the investment is profitable. It analyzes the profitability of the project.
At
YEAR | CASH FLOW ($) |
0 | -40,000,000 |
1 | 15,000,000 |
2 | 15,000,000 |
3 | 15,000,000 |
4 | 15,000,000 |
5 | 15,000,000 |
6 | 15,000,000 |
7 | 15,000,000 |
8 | 15,000,000 |
9 | 15,000,000 |
10 | 15,000,000 |
IRR | 35.7333% |
The calculation of Beta,
Before the NPV becomes negative, the highest value of beta is 3.47
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Chapter 9 Solutions
INVESTMENTS (LOOSELEAF) W/CONNECT
- Your division is considering two investment projects, each of which requires an up-front expenditure of 25 million. You estimate that the cost of capital is 10% and that the investments will produce the following after-tax cash flows (in millions of dollars): a. What is the regular payback period for each of the projects? b. What is the discounted payback period for each of the projects? c. If the two projects are independent and the cost of capital is 10%, which project or projects should the firm undertake? d. If the two projects are mutually exclusive and the cost of capital is 5%, which project should the firm undertake? e. If the two projects are mutually exclusive and the cost of capital is 15%, which project should the firm undertake? f. What is the crossover rate? g. If the cost of capital is 10%, what is the modified IRR (MIRR) of each project?arrow_forwardHemmingway, 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.arrow_forwardTropical Sweets is considering a project that will cost $70 million and will generate expected cash flows of $30 million per year for 3 years. The cost of capital for this type of project is 10%, and the risk-free rate is 6%. After discussions with the marketing department, you learn that there is a 30% chance of high demand with associated future cash flows of $45 million per year. There is also a 40% chance of average demand with cash flows of $30 million per year as well as a 30% chance of low demand with cash flows of only $15 million per year. What is the expected NPV?arrow_forward
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