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Chapter13
13-1
a. Project A:
0 10%
|
-10,000
1
|
6,000
2
|
8,000
0 10%
|
-10,000
1
|
4,000
2
|
4,000
3
|
4,000
4
|
4,000
0 k = 10%
|
-10,000
1
|
6,000
2
|
8,000
-10,000
-2,000
3
|
6,000
4
|
8,000
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
13-3
Since Projects C and D are now mutually exclusive only one of them can be
accepted.
The project with the higher NPV should now be chosen.
Therefore, Project D should be selected over Project C. The projects now
selected are A, B, D, and E with an optimal capital budget of
$4 million.
13-4
Projects
A
B
C
D
E
F
G
Risk
High
Average
Average
Average
Average
Low
Low
Risk-adjusted
WACC
14.5%
12.5
12.5
12.5
12.5
10.5
10.5
IRR
14.0%
13.5
13.2
13.0
12.7
12.3
12.2
Decision
Reject
Accept
Accept
Accept
Accept
Accept
Accept
13-6
Plane A: Expected life = 5 years; Cost = $100 million; NCF = $30 million;
COC = 12%.
Plane B: Expected life = 10 years; Cost = $132 million; NCF = $25
million; COC = 12%.
A:
012% 1
|
|
-100
30
2
|
30
3
|
30
4
|
30
5
|
30
6
|
30
-100
-70
7
|
30
8
|
30
9
|
30
10
|
30
Enter these values into the cash flow register: CF 0 = -100; CF1-4 = 30;
CF5 =
-70;
CF6-10 = 30. Then enter I = 12, and press the NPV key to get NPV A = 12.764
$12.76 million.
B:
012% 1
|
|
-132
25
2
|
25
3
|
25
4
|
25
5
|
25
6
|
25
7
|
25
8
|
25
9
|
25
10
|
25
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
Enter these cash flows into the cash flow register, along with the
interest
rate,
and press the NPV key to get NPVB = 9.256 $9.26 million.
Project A is the better project and will increase the company's value
by $12.76 million.
13-7
A:
010%
|
-10
1
|
4
2
|
4
3
|
4
4
|
4
-10
-6
5
|
4
6
|
4
7
|
4
8
|
4
010% 1
|
|
-15
3.5
2
|
3.5
3
|
3.5
4
|
3.5
5
|
3.5
6
|
3.5
7
|
3.5
8
|
3.5
a.
012%
|
-20
1
|
3
2
|
3
20
|
3
Tax imposed
25% Prob.
k0 = 12% 1
|
|
0
-20
2
|
2.4
3
|
2.4
|
0
|
3.2
|
3.2
|
-20
3.2
NPV @
21
Yr. 0
|
2.4 -$1.8512
|
3.2
3.4841
Note though, that if the tax is imposed, the NPV of the project is
negative and therefore would not be undertaken.
The value of this
option of waiting one year is evaluated as 0.25($0) + (0.75)($3.4841)
= $2.6131 million.
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
Since the NPV of waiting one year is greater than going ahead and
proceeding with the project today, it makes sense to wait.
13-9
13-10 a.
010%
-8
2
|
-9
3
|
2.2
4
|
2.2
5
|
2.2
NPV @
6
Yr. 0
|
2.2 -$1.6746
|
90% Prob. 0
|
-9
|
4.2
|
4.2
|
4.2
|
4.2
|
0
3.5648
If the cash flows are only $2.2 million, the NPV of the project is
negative and, thus, would not be undertaken. The value of the option
of waiting two years is evaluated as 0.10($0) + 0.90($3.5648) =
$3.2083 million.
Since the NPV of waiting two years is less than going ahead and
proceeding with the project today, it makes sense to drill today.
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
13-11 a.
013%
|
-300
1
|
40
2
|
40
20
|
40
Dont purchase.
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
b. Wait 1 year:
k0 = 13% 1
|
|
50% Prob. 0
-300
2
|
30
3
|
30
4
|
30
|
50% Prob. 0
|
50
|
50
|
50
|
-300
NPV @
Yr. 0
21
|
30
-$78.9889
|
50
45.3430
If the cash flows are only $30 million per year, the NPV of the
project is negative. However, weve not considered the fact that the
company could then be sold for $280 million. The decision tree would
then look like this:
0 = 13% 1
k
|
|
50% Prob. 0
-300
2
|
30
3
|
30 + 280
4
|
0
|
50% Prob. 0
|
50
|
50
|
50
|
-300
NPV @
Yr. 0
21
|
0
-$27.1468
|
50
45.3430
0 12%
|
-6,200,000
1
|
600,000
14
|
600,000
15
|
600,000
Using
a
financial
calculator,
input
the
following
data:
CF0 = -6,200,000; CF1-15 = 600,000; I = 12; and then solve for NPV =
-$2,113,481.31.
b.
0 12%
|
-6,200,000
1
|
1,200,000
14
|
1,200,000
15
|
1,200,000
Using
a
financial
calculator,
input
the
following
data:
CF0 = -6,200,000; CF1-15 = 1,200,000; I = 12; and then solve for NPV =
$1,973,037.39.
c. If they proceed with the project today, the projects expected NPV =
(0.5 -$2,113,481.31) + (0.5 $1,973,037.39) = -$70,221.96.
So,
Nevada Enterprises would not do it.
d. Since the projects NPV with the tax is negative, if the tax were
imposed the firm would abandon the project. Thus, the decision tree
looks like this:
Answers and Solutions: 13 - 6
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
0k = 12%
1
50% Prob.
|
|
Taxes
-6,200,000
6,000,000
No Taxes
|
50% Prob. -6,200,000
|
1,200,000
2
|
0
|
1,200,000
15
|
0
NPV @
Yr. 0
-$
842,857.14
|
1,200,000
1,973,037.39
Expected NPV $ 565,090.13
Yes, the existence of the abandonment option changes the expected NPV
of the project from negative to positive. Given this option the firm
would take on the project because its expected NPV is $565,090.13.
e.
50% Prob.
Taxes
0k = 12%
1
|
|
NPV = ?
-1,500,000
wouldnt do
+300,000 = NPV @ t = 1
No Taxes
50% Prob.
|
NPV = ?
|
-1,500,000
+4,000,000 = NPV @ t = 1
NPV @
Yr. 0
$
0.00
2,232,142.86
Expected NPV $1,116,071.43
If the firm pays $1,116,071.43 for the option to purchase the land,
then the NPV of the project is exactly equal to zero.
So the firm
would not pay any more than this for the option.
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
SPREADSHEET
CYBERPROBLEM
PROBLEM
13-13 The detailed solution for the spreadsheet problem is available on the
instructors resource CD-ROM and on the instructors side of the Harcourt
College Publishers web site, http://www.harcourtcollege.com/finance/
brigham.
Computer/Internet Applications: 13 - 8
Harcourt, Inc.
INTEGRATED CASE
HIS GROUP
YEAR
0
1
2
3
4
BOTH PROJECTS MAY BE REPEATED AND BOTH ARE OF AVERAGE RISK, SO THEY
SHOULD BE EVALUATED AT THE FIRM'S COST OF CAPITAL, 10 PERCENT.
WHICH ONE SHOULD BE CHOSEN?
ANSWER:
0 10%
|
-100,000
1
|
59,000
2
|
59,000
-100,000
-41,000
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
3
|
59,000
4
|
59,000
Integrated Case: 13 - 9
CF0 =
-100,000; CF1 = 59,000; CF2 = -41,000; CF3-4 = 59,000; I = 10; AND THEN
SOLVE FOR NPV = $4,377.43.
PROJECT L:
0 10%
|
-100,000
1
|
33,500
2
|
33,500
3
|
33,500
4
|
33,500
CF0 =
-100,000; CF1-4 = 33,500; I = 10; AND THEN SOLVE FOR NPV = $6,190.49.
PROJECT L SHOULD BE CHOSEN SINCE IT HAS A HIGHER NPV THAN PROJECT S.
B.
ANSWER:
B.
ANSWER:
C.
Integrated Case: 13 - 10
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
IF THE MARKET IS
IF THE MARKET IS
IF 21ST CENTURY
SHOULD 21ST
2
|
43,500
3
|
43,500
4
|
43,500
5
|
43,500
NPV
@ t = 1
$37,889.15
WEAK MKT.
50% PROB.
|
23,500
|
23,500
|
23,500
|
23,500
-25,508.16
|
0
|
-100,000
HOWEVER, IN A WEAK MARKET THE FIRM WILL NOT UNDERTAKE PROJECT L SINCE
ITS NPV < 0.
D.
NOW LETS ASSUME THAT THERE IS MORE UNCERTAINTY ABOUT THE FUTURE CASH
FLOWS.
MORE SPECIFICALLY, ASSUME THAT THE YEARLY CASH FLOWS ARE NOW
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
Integrated Case: 13 - 11
ANSWER:
2
|
53,500
3
|
53,500
4
|
53,500
5
|
53,500
NPV
@ t = 1
$69,587.80
WEAK MKT.
50% PROB.
|
13,500
|
13,500
|
13,500
|
13,500
-57,206.82
|
0
|
-100,000
IN A WEAK MARKET THE FIRM WILL NOT UNDERTAKE PROJECT L SINCE ITS NPV
< 0.
(0.5)($69,587.80) = $34,793.90.
SHOULD WAIT TO GET MORE INFORMATION ABOUT THE MARKET RATHER THAN
UNDERTAKING PROJECT L TODAY BECAUSE THE NPV IS $31,630.82 COMPARED TO
$6,190.49, THE NPV OF DOING IT TODAY.
THE MORE VARIABLE THE CASH FLOWS (THE MORE UNCERTAINTY) THE LESS
WILLING THE FIRM WILL BE TO INVEST IN THE PROJECT TODAY.
FACTORS THE FIRM SHOULD CONSIDER WHEN DECIDING WHEN TO INVEST:
1. DELAYING THE PROJECT MEANS THAT CASH FLOWS COME LATER RATHER THAN
SOONER.
2. IT
MIGHT
MAKE
SENSE
TO
PROCEED
TODAY
IF
THERE
ARE
IMPORTANT
E.
PROJECT Y
CASH OUTFLOWS
-$200,000
-100,000
-100,000
-100,000
CASH INFLOWS
$
0
180,000
180,000
180,000
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
WHAT IS
1
|
80,000
2
|
80,000
3
|
80,000
CF0 =
-200,000; CF1-3 = 80,000; I = 10; AND THEN SOLVE FOR NPV = -$1,051.84.
E.
KELLER ESTIMATES
THAT THERE IS A 60 PERCENT CHANCE THE CUSTOMER WILL USE THE PRODUCT,
IN WHICH CASE THE PROJECT WILL PRODUCE AFTER-TAX CASH INFLOWS OF
$250,000.
HOWEVER, THERE IS A 40 PERCENT CHANCE THE CUSTOMER WILL NOT USE THE
PRODUCT,
INFLOWS
IN
WHICH
OF
-$25,000.
ONLY
CASE
THE
$75,000.
PROJECT
THUS,
WILL
ITS
NET
PRODUCE
CASH
AFTER-TAX
FLOWS
WOULD
CASH
BE
1
|
150,000
2
|
150,000
3
|
150,000
CF1-3
150,000;
10;
AND
THEN
SOLVE
FOR
CF0 =
NPV
$173,027.80.
CUSTOMER DOESNT USE PRODUCT (40% PROBABILITY)
0 10%
|
-200,000
1
|
-25,000
2
|
-25,000
3
|
-25,000
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
Integrated Case: 13 - 13
CF1-3
-25,000;
10;
AND
THEN
SOLVE
FOR
CF0 =
NPV
-$262,171.30.
E.
3. WHILE 21ST CENTURY DOES NOT HAVE THE OPTION TO DELAY THE PROJECT, IT
WILL KNOW ONE YEAR FROM NOW IF THE KEY CUSTOMER HAS SELECTED THE
PRODUCT.
IF IT ABANDONS THE
PROJECT, IT WILL NOT RECEIVE ANY CASH FLOWS AFTER YEAR 1, AND IT WILL
NOT INCUR ANY OPERATING COSTS AFTER YEAR 1.
60% PROB.
0
|
-200,000
1
|
150,000
40% PROB.
|
-200,000
|
-25,000
AGAIN,
ASSUMING
COST
OF
2
|
150,000
CAPITAL
OF
10
3
|
150,000
PERCENT,
WHAT
IS
THE
SHOULD 21ST
2
|
150,000
3
|
150,000
|
-25,000
NPV @ t = 0
$173,027.80
-222,727.27
4. UP UNTIL NOW WE HAVE ASSUMED THAT THE ABANDONMENT OPTION HAS NOT
AFFECTED
THE
REASONABLE?
PROJECTS
COST
OF
CAPITAL.
IS
THIS
ASSUMPTION
CAPITAL?
Integrated Case: 13 - 14
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
ANSWER:
[SHOW
S13-19
HERE.]
IT
IS
NOT
REASONABLE
TO
ASSUME
THAT
THE
HAVING THE
F.
PROJECT Z HAS
GROUP RECOGNIZE THAT IF 21ST CENTURY GOES AHEAD WITH PROJECT Z TODAY,
THERE IS A 10 PERCENT CHANCE THAT THIS WILL LEAD TO SUBSEQUENT
OPPORTUNITIES THAT HAVE A NET PRESENT VALUE AT t = 5 EQUAL TO
$3,000,000.
OPTIONS, KELLER AND HIS GROUP UNDERSTAND THAT THE COMPANY WILL CHOOSE
TO DEVELOP THESE SUBSEQUENT OPPORTUNITIES ONLY IF THEY APPEAR TO BE
PROFITABLE AT t = 5.
2
|
100,000
3
|
100,000
90%
|
PROB.-500,000
|
100,000
|
100,000
|
100,000
4
|
100,000
5
|
100,000
3,000,000
3,100,000
|
|
100,000 100,000
-1,000,000
NPV @ t = 0
$1,562,758.19
-139,522.38
WILL NOT DO
THEREFORE, THE
CASH FLOWS FOR THAT BRANCH OF THE DECISION TREE INCLUDE ONLY THE
$500,000 OUTLAY AND THE $100,000 INFLOWS.
Harcourt, Inc. items and derived items copyright 2000 by Harcourt, Inc.
Integrated Case: 13 - 15