1. You possess a small manufacturing facility making $2 million annually. Depending on along-term government contract decision, next year, your revenue could either rise by 20%or drop by 25%, both outcomes having an equal chance, and maintaining that level for theplant's operational duration. Additional costs tally up to $1.6 million per year. You can sellthe plant at any time to a large conglomerate for $5 million and your cost of capital is 10%.a. If the government does not award you the contract and your sales decrease by 25%,what will be the value of your plant?b. Given the embedded option to sell the plant, compute the value of the plant.c. Suppose that you are not able to sell the plant, but you can shut it down at any time atno cost. What is the value of the option to abandon production? |d. Companies sometimes proceed with capital projects despite their negative NPV.Critically discuss what drives this decision.

Explanationa. Calculation of Plant Value if Contract is Lost:Calculate Revenue Reduction: Revenue…

Answered: 1. You possess a small manufacturing…

Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter19: Capital Investment

Section: Chapter Questions

Problem 15E: Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided...

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Falkland, Inc., is considering the purchase of a patent that has a cost of $50,000 and an estimated revenue producing life of 4 years. Falkland has a cost of capital of 8%. The patent is expected to generate the following amounts of annual income and cash flows: A. What is the NPV of the investment? B. What happens if the required rate of return increases?
The Rodriguez Company is considering an average-risk investment in a mineral water spring project that has an initial after-tax cost of 170,000. The project will produce 1,000 cases of mineral water per year indefinitely, starting at Year 1. The Year-1 sales price will be 138 per case, and the Year-1 cost per case will be 105. The firm is taxed at a rate of 25%. Both prices and costs are expected to rise after Year 1 at a rate of 6% per year due to inflation. The firm uses only equity, and it has a cost of capital of 15%. Assume that cash flows consist only of after-tax profits because the spring has an indefinite life and will not be depreciated. a. What is the present value of future cash flows? (Hint: The project is a growing perpetuity, so you must use the constant growth formula to find its NPV.) What is the NPV? b. Suppose that the company had forgotten to include future inflation. What would they have incorrectly calculated as the projects NPV?
Gina Ripley, president of Dearing Company, is considering the purchase of a computer-aided manufacturing system. The annual net cash benefits and savings associated with the system are described as follows: The system will cost 9,000,000 and last 10 years. The companys cost of capital is 12 percent. Required: 1. Calculate the payback period for the system. Assume that the company has a policy of only accepting projects with a payback of five years or less. Would the system be acquired? 2. Calculate the NPV and IRR for the project. Should the system be purchasedeven if it does not meet the payback criterion? 3. The project manager reviewed the projected cash flows and pointed out that two items had been missed. First, the system would have a salvage value, net of any tax effects, of 1,000,000 at the end of 10 years. Second, the increased quality and delivery performance would allow the company to increase its market share by 20 percent. This would produce an additional annual net benefit of 300,000. Recalculate the payback period, NPV, and IRR given this new information. (For the IRR computation, initially ignore salvage value.) Does the decision change? Suppose that the salvage value is only half what is projected. Does this make a difference in the outcome? Does salvage value have any real bearing on the companys decision?
Gardner Denver Company is considering the purchase of a new piece of factory equipment that will cost $420,000 and will generate $95,000 per year for 5 years. Calculate the IRR for this piece of equipment. For further Instructions on internal rate of return in Excel, see Appendix C.
Caduceus Company is considering the purchase of a new piece of factory equipment that will cost $565,000 and will generate $135,000 per year for 5 years. Calculate the IRR for this piece of equipment. For further instructions on internal rate of return In Excel, see Appendix C.
4. Your company is considering the introduction of a new product line. The initial investment required for this project is $500,000, and annual maintenance costs are anticipated to be $35,000. Annual operating costs will be directly proportional to the level of production at $7.50 per unit, and each unit of product can be sold for $50. If the MARR is 15% and the project has a life of 5 years, what is the minimum annual production level for which the project is economically viable?
You own a small manufacturing plant that currently generates revenues of $2 million per year. Next year, based upon a decision on a long-term government contract, your revenues will either increase by 20% or decrease by 25%, with equal probability, and stay at that level as long as you operate the plant. Other costs run $1.6 million per year. You can sell the plant at any time to a large conglomerate for $5 million and your cost of capital is 10%. Assume that it will cost $1 million to shut down the plant, but you are able to sell the plant for $5 million at any time. What is the value of the option to sell the plant?
Mosaic is evaluating a manufacturing plant that has the potential to generate revenue of $2 million per year. Based on uncertainty surrounding its long term government contract, next year’s revenue will either increase by 20% or decrease by 25%, with equal probability and then stay the same forever. Mosaic projected that the costs will be constant at $1.2 million per year. Next year, Mosaic has the option to sell the plant for $3 million. Its cost of capital is 20%. Assume a zero tax rate and perpetual cash flows.What is the value of the option to sell the plant? A. $0.5 million B. $0.75 million C. $1.25 million D. $1.5 million
Mosaic is evaluating a manufacturing plant that has the potential to generate revenue of $2 million per year. Based on uncertainty surrounding its long term government contract, next year’s revenue will either increase by 20% or decrease by 25%, with equal probability and then stay the same forever. Mosaic projected that the costs will be constant at $1.2 million per year. Next year, Mosaic has the option to sell the plant for $3 million. Its cost of capital is 20%. Assume a zero tax rate and perpetual cash flows.What is the expected value of the plant with the option to sell it? A. $3.75 million B. $3.90 million C. $4.25 million D. $4.50 million
Solar Calculator Company proposes to invest $9 million in a new calculator-making plant. Fixed costs are $3 million per year. A solar calculator costs $10 per unit to manufacture and sells for $50 per unit. If the plant lasts for three years and the cost of capital is 10% p.a., what is the break-even level (i.e., NPV = 0) of annual sales? Assume that revenues and costs occur at the end of each year. Assume straight line depreciation and tax rate of 20%. a. 169,345 units b. 263,095 units c. 228,000 units d. None of the above.
1. Primus Corp. is planning to convert an existing warehouse into a new plant that will increase its production capacity by 45 percent. The cost of this project will be $7,125,000. It will result in additional cash flows of $1,875,000 for the next eight years. The company uses a discount rate of 12 percent.  What is the payback period? What is the NPV for the project? What is the IRR for the project?
An investment of P200,000 can be made in a project that will produce a uniform annual revenue of P145,000 for 5 years and then have a salvage value of 10% of the investment. Out-of-pocket costs for operation and maintenance will be P60,000 per year. Taxes and insurance will be 4% of the first cost per year. The company expects capital to earn not less than 22% before income taxes. Is this a desirable investment? What is the payback period of the investment? Compute the rate of return. What is the net annual profit using annual worth method? What is the net present worth of net cash flow? The rate of return is [Select] The net annual profit is [Select] The net present worth of net cash flow is [ Select] Is this a desirable investment? [ Select ] The payback period is [ Select] years.

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