Ch. 10 Case Analysis #3 <\/p>\n
Here are the net cash flows (in thousands of dollars):<\/p>\n
\u00a0<\/p>\n
Expected Net Cash Flows<\/p>\n
Year<\/p>\n
Franchise L<\/p>\n
Franchise S<\/p>\n
0<\/p>\n
\u2212$100<\/p>\n
\u2212$100<\/p>\n
1<\/p>\n
\u00a0\u00a0\u00a0\u00a0\u00a0\u00a010<\/p>\n
\u00a0\u00a0\u00a0\u00a0\u00a0\u00a070<\/p>\n
2<\/p>\n
\u00a0\u00a0\u00a0\u00a0\u00a0\u00a060<\/p>\n
\u00a0\u00a0\u00a0\u00a0\u00a0\u00a050<\/p>\n
3<\/p>\n
\u00a0\u00a0\u00a0\u00a0\u00a0\u00a080<\/p>\n
\u00a0\u00a0\u00a0\u00a0\u00a0\u00a020<\/p>\n
Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows.<\/p>\n
You also have made subjective risk assessments of each franchise and concluded that both franchises have risk characteristics that require a return of 10%. You must now determine whether one or both of the franchises should be accepted.<\/p>\n
What is capital budgeting?<\/p>\n
Capital budgeting is the way to allocate resources in a efficent manner which increased the value of the firm. It can be used to asses whether a firms long term investments are worth funding through there returns. If it is projected to provide above the required rate of return it will be funded but if it causes negative cash flow the fund will be allocated elsewhere. <\/p>\n
What is the difference between independent and mutually exclusive projects?<\/p>\n
Define the term\u00a0net present value (NPV). What is each franchise\u2019s NPV?<\/p>\n
What is the rationale behind the NPV method? According to NPV, which franchise or franchises should be accepted if they are independent? Mutually exclusive?<\/p>\n
Would the NPVs change if the cost of capital changed?<\/p>\n
Define the term\u00a0internal rate of return (IRR). What is each franchise\u2019s IRR?<\/p>\n
How is the IRR on a project related to the YTM on a bond?<\/p>\n
What is the logic behind the IRR method? According to IRR, which franchises should be accepted if they are independent? Mutually exclusive?<\/p>\n
Would the franchises\u2019 IRRs change if the cost of capital changed?<\/p>\n
Draw NPV profiles for Franchises L and S. At what discount rate do the profiles cross?<\/p>\n
Look at your NPV profile graph without referring to the actual NPVs and IRRs. Which franchise or franchises should be accepted if they are independent? Mutually exclusive? Explain. Are your answers correct at any cost of capital less than 23.6%?<\/p>\n
What is the underlying cause of ranking conflicts between NPV and IRR?<\/p>\n
Define the term\u00a0modified IRR (MIRR). Find the MIRRs for Franchises L and S.<\/p>\n
What does the profitability index (PI) measure? What are the PIs of Franchises S and L?<\/p>\n
What is the payback period? Find the paybacks for Franchises L and S.<\/p>\n
What is the rationale for the payback method? According to the payback criterion, which franchise or franchises should be accepted if the firm\u2019s maximum acceptable payback is 2 years and if Franchises L and S are independent? If they are mutually exclusive?<\/p>\n
What is the difference between the regular and discounted payback periods?<\/p>\n
What is the main disadvantage of discounted payback? Is the payback method of any real usefulness in capital budgeting decisions?<\/p>\n
As a separate project (Project P), you are considering sponsorship of a pavilion at the upcoming World\u2019s Fair. The pavilion would cost $800,000, and it is expected to result in $5 million of incremental cash inflows during its single year of operation. However, it would then take another year, and $5 million of costs, to demolish the site and return it to its original condition. Thus, Project P\u2019s expected net cash flows look like this (in millions of dollars):<\/p>\n
Year<\/p>\n
Net Cash Flows<\/p>\n
0<\/p>\n
\u2212$0.8<\/p>\n
1<\/p>\n
\u00a0\u00a0\u00a0\u00a05.0<\/p>\n
2<\/p>\n
\u00a0\u00a0\u22125.0<\/p>\n
The project is estimated to be of average risk, so its cost of capital is 10%.<\/p>\n
What are normal and nonnormal cash flows?<\/p>\n
What is Project P\u2019s NPV? What is its IRR? Its MIRR?<\/p>\n
Draw Project P\u2019s NPV profile. Does Project P have normal or nonnormal cash flows? Should this project be accepted?<\/p>\n
In an unrelated analysis, you have the opportunity to choose between the following two mutually exclusive projects, Project T (which lasts for two years) and Project F (which lasts for four years):<\/p>\n
The projects provide a necessary service, so whichever one is selected is expected to be repeated into the foreseeable future. Both projects have a 10% cost of capital.<\/p>\n
What is each project\u2019s initial NPV without replication?<\/p>\n
What is each project\u2019s equivalent annual annuity?<\/p>\n
Apply the replacement chain approach to determine the projects\u2019 extended NPVs. Which project should be chosen?<\/p>\n
Assume that the cost to replicate Project T in 2 years will increase to $105,000 due to inflation. How should the analysis be handled now, and which project should be chosen?<\/p>\n
You are also considering another project that has a physical life of 3 years; that is, the machinery will be totally worn out after 3 years. However, if the project were terminated prior to the end of 3 years, the machinery would have a positive salvage value. Here are the project\u2019s estimated cash flows:<\/p>\n
Year<\/p>\n
Initial Investment and Operating Cash Flows<\/p>\n
End-of-Year Net Salvage Value<\/p>\n
0<\/p>\n
\u2212$5,000<\/p>\n
$5,000<\/p>\n
1<\/p>\n
\u00a0\u00a0\u00a0\u00a02,100<\/p>\n
\u00a0\u00a03,100<\/p>\n
2<\/p>\n
\u00a0\u00a0\u00a0\u00a02,000<\/p>\n
\u00a0\u00a02,000<\/p>\n
3<\/p>\n
\u00a0\u00a0\u00a0\u00a01,750<\/p>\n
\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a0\u00a00<\/p>\n
Using the 10% cost of capital, what is the project\u2019s NPV if it is operated for the full 3 years? Would the NPV change if the company planned to terminate the project at the end of Year 2? At the end of Year 1? What is the project\u2019s optimal (economic) life?<\/p>\n","protected":false},"excerpt":{"rendered":"
Ch. 10 Case Analysis #3 Here are the net cash flows (in thousands of dollars): \u00a0 Expected Net Cash Flows Year Franchise L Franchise S 0 \u2212$100 \u2212$100 1 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a010 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a070 2 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a060 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a050 3 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a080 \u00a0\u00a0\u00a0\u00a0\u00a0\u00a020 Depreciation, salvage values, net working capital requirements, and tax effects are all included in these cash flows. You […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[10],"class_list":["post-106913","post","type-post","status-publish","format-standard","hentry","category-research-paper-writing","tag-writing"],"_links":{"self":[{"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/posts\/106913","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/comments?post=106913"}],"version-history":[{"count":0,"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/posts\/106913\/revisions"}],"wp:attachment":[{"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/media?parent=106913"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/categories?post=106913"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/papersspot.com\/blog\/wp-json\/wp\/v2\/tags?post=106913"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}