CHAPTER 6 Making Investment Decisions with the Net Present Value Rule Answers to Problem Sets 1. a‚ b‚ d‚ g‚ h; c is a sunk cost. e is an overhead cost. f is not an incremental cash flow because depreciation is not a cash flow. i is a sunk cost. Est. Time: 01 - 05 2. Real cash flow = 100‚000/1.04 = $96‚154. The real discount rate is calculated as 1 + nominal rate / 1+ inflation rate − 1. Therefore‚ 1.08/1.04 − 1 = .03846. PV = [pic] Est
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CAPITAL BUDGETING Cost of Capital Evaluating Cash Flows Payback‚ discounted payback NPV IRR‚ MIRR The Cost of Capital • Cost of Capital Components – Debt – Common Equity • WACC Should we focus on historical (embedded) costs or new (marginal) costs? The cost of capital is used primarily to make decisions which involve raising and investing new capital. So‚ we should focus on marginal costs. What types of long-term capital do organizations use? nLong-term debt nEquity Weighted
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largely depend on a good estimate of the rights present value at the contract date. To less would not tempt the studios (inquiries indicated not less than USD 2 million per movie) and too much would not make the business profitable. Calculating the NPV of all the profitable sequels of a studio. The data used assumes that the sequel’s estimated negative cost and US theater rentals are 120% and 70% respectively‚ of the corresponding items for the first film. In exhibit 7 we find the present value
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Frank Thomas by setting NPV = 0 where NPV = PV (net cash proceeds from the repurchase price) + PV (Annual cash flows from the property) – Thomas initial investment‚ calculated at a 15% IRR. With an IRR of 15%‚ the present value of all the annual cash flow is $770‚347.27. PV (net cash proceeds) = $770‚347.27 - $2‚100‚000 = -$1‚329‚652.73 FV = $1‚329‚652.73*(1.15)^7 Net cash proceeds = $3‚536‚902.7 Calculations of capital gains tax owed: (0.2)(X – $8‚669‚384) = Y Calculations of net cash proceeds:
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Summary 2.0 Sales Forecast 2.1 Sales Forecast 2.2 Methods and Assumptions 3.0 Capital Expenditure Budget 4.0 Investment Analysis 4.1 Cash Flows 4.2 NPV Analysis 4.3 Rate of Return Calculations 4.4 Payback Period Calculations 5.0 Pro Forma Financial Statements 5.1 Pro Forma Income Statement 5.2 Pro Forma Balance Sheet 5.3 Pro Forma Cash Budget 6.0 Works Cited 7.0 Appendices
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cost of a project is $100‚000. Sales are for five years‚ starting next year. The company earns $0.50 per sale‚ and expects to sell 60‚000 units per year. If the interest rate is 5%‚ the NPV is -100‚000 +129‚884 = 29‚884. At what level of sales does the project break even in terms of NPV? Set PV = -100‚000 (so that NPV = 0) and find the amount of sales per year. The answer is sales in dollars = 23‚097 so that sales in units = 46‚194. Break-even analysis is a good starting point‚ but it ignores some
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profit concept thus expose the weakness of profit maximization. O It doesn’t consider the time value of money or NPV of cash inflow. O It fails to consider the fluctuation of profit. O Despite this lacuna‚ Profit does matter for any kind of business. Ensuring continual profit ensures maximization of the shareholder’s wealth. Wealth Maximization: It is also known as value maximization or NPV maximization. This is possible only when‚ the firm pursues policies which would add the market value of the
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like cost‚ complexity‚ time and irreversibility are evaluated. The calculations involved when applying four common techniques to investing project cash flows are as follows: A. The payback is the time it takes for [Cumulative Cash Flows after t =0] to exceed [Cash Flow at t=0] B. The internal rate of return (IRR) is the rate at which [Sum of Discounted Cash Flows from t=1 to t=n] = [Cash Flow at t=0] C. The net present value is NPV is the sum of all Discounted Cash Flows‚ including the initial cash
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(150.00) $ 1.00 518.58 $ 553.98 $ 591.64 $ 631.68 $ 674.27 $ 719.55 0.00 0.34 1.59 $ 1.00 518.58 $ 1.08 0.22 120.04 $ 1.17 0.05 27.78 $ 1.26 0.01 6.43 $ 1.36 0.00 1.49 $ 1.47 NPV of Expected Cash Flow per Guest Total NPV of CLTV $ $ (150.00) $ 461.09 480.17 $ 102.92 $ 22.05 $ 4.72 $ 1.01 $ 0.22 Increase in CLTV per Guest of New Marketing Plan Multiplied by # of Guests to Obtain Increase in Profit of Rosewood
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1) Prepare the manufacturing staff’s calculations for the three alternatives (please refer to the attachments): a) In the first set of calculations‚ the staff used a discount rate of 20%‚ a five-year time horizon‚ and ignored taxes and terminal value. What is the relative attractiveness of these three alternatives? During the period of 5 years (from 1994 to 1998)‚ if the discount rate is 20%‚ Waltham plant is the only one that has a positive amount in NPV. The total net present value of this
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