Foundations Of Finance
10th Edition
ISBN: 9780134897264
Author: KEOWN, Arthur J., Martin, John D., PETTY, J. William
Publisher: Pearson,
expand_more
expand_more
format_list_bulleted
Concept explainers
Videos
Textbook Question
Chapter 11, Problem 16SP
(Real options and capital budgeting) You have come up with a great idea for a Tex-Mex-Thai fusion restaurant. After doing a financial analysis of this venture, you estimate that the initial outlay will be $6 million. You also estimate that there is a 50 percent chance that this new restaurant will be well received and will produce annual cash flows of $800,000 per year forever (a perpetuity), while there is a 50 percent chance of it producing a cash flow of only $200,000 per year forever (a perpetuity) if it isn’t received well.
- a. What is the
NPV of the restaurant if the requiredrate of return you use to discount the project cash flows is 10 percent? - b. What are the real options that this analysis may be ignoring?
- c. Explain why the project may be worthwhile, even though you have just estimated that its NPV is negative.
Expert Solution & Answer
Want to see the full answer?
Check out a sample textbook solution
Students have asked these similar questions
You decide to open a new restaurant. The initial cost ( investment) is 750 000 TL. The forecasted cash flows that you expect to gain from this restaurant are 150 000 TL every year for 9 years. If the discount rate is %28, calculate the net present value (NPV), and is this a feasible project?
(Real options and capital budgeting) You have come up with a great idea for a Tex-Mex-Thai fusion restaurant. After doing a financial analysis of this venture, you estimate that the initial outlay will be $6 million.
You also estimate that there is a 50 percent chance that this new restaurant will be well received and will produce annual cash flows of $760,000 per year forever (a perpetuity), while there is a 50 percent chance
of it producing a cash flow of only $180,000 per year forever (a perpetuity) if it isn't received well.
a. What is the NPV of the restaurant if the required rate of return you use to discount the project cash flows is 12 percent?
b. What are the real options that this analysis may be ignoring?
c. Explain why the project may be worthwhile even though you have just estimated that its NPV is negative?
a. Assume the required rate of return you use to discount the project cash flows is 12%. What is the NPV of the restaurant if things go well?
(Round to the nearest…
Your firm is considering a project that will cost $4.719 million up front, generate cash flows of $3.55 million per year
for 3 years, and then have a cleanup and shutdown cost of $5.96 million in the fourth year.
a. How many IRRS does this project have?
b. Create an NPV profile for this project (plot the NPV as a function of the discount rate-see the appendix). (NOTE:
students will solve this question part using Excel only. A student response is not included in MyFinanceLab).
c. Given a cost of capital of 9.9% should this project be accepted?
a. The project has IRRS. (Select from the drop-down menu.)
2
3
4
Chapter 11 Solutions
Foundations Of Finance
Ch. 11.A - Prob. 1MCCh. 11.A - Prob. 2MCCh. 11 - Prob. 1RQCh. 11 - Prob. 2RQCh. 11 - If a project requires an additional investment in...Ch. 11 - Prob. 4RQCh. 11 - Prob. 5RQCh. 11 - Prob. 6RQCh. 11 - Prob. 1SPCh. 11 - (Relevant cash flows) Captins Cereal is...
Ch. 11 - Prob. 3SPCh. 11 - Prob. 4SPCh. 11 - Prob. 5SPCh. 11 - Prob. 6SPCh. 11 - Prob. 7SPCh. 11 - Prob. 9SPCh. 11 - Prob. 10SPCh. 11 - Prob. 11SPCh. 11 - Prob. 12SPCh. 11 - Prob. 15SPCh. 11 - (Real options and capital budgeting) You have come...Ch. 11 - (Real options and capital budgeting) Go-Power...Ch. 11 - (Real options and capital budgeting) McDoogals...Ch. 11 - (Risk-adjusted NPV) The Hokie Corporation is...Ch. 11 - (Risk-adjusted discount rates and risk classes)...Ch. 11 - Prob. 1MCCh. 11 - Prob. 2MCCh. 11 - Prob. 3MCCh. 11 - Prob. 7MCCh. 11 - Prob. 8MCCh. 11 - Prob. 9MCCh. 11 - Should the project be accepted? Why or why not?Ch. 11 - Prob. 11MCCh. 11 - Prob. 12MCCh. 11 - Prob. 13MCCh. 11 - Prob. 14MC
Knowledge Booster
Learn more about
Need a deep-dive on the concept behind this application? Look no further. Learn more about this topic, finance and related others by exploring similar questions and additional content below.Similar questions
- You are considering opening a new plant. The plant will cost $100.7 million upfront and will take one year to build. After that, it is expected to produce profits of $28.6 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 6.3%. Should you make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule? Here is the cash flow timeline for this problem: Years 0 2 + 28.6 3 28.6 4 + 28.6 Cash Flow ($ million) - 100.7 Calculate the NPV of this investment opportunity if your cost of capital is 6.3%. The NPV of this investment opportunity is $ million. (Round to two decimal places.) Forever 28.6arrow_forwardYou are considering opening a new plant. The plant will cost $95.1 million upfront and will take one year to build. After that, it is expected to produce profits of $29.2 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 7.4 %. Should you make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule?arrow_forwardYou are considering opening a new plant. The plant will cost $95.3 million upfront and will take one year to build. After that, it is expected to produce profits of $30.9 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 6.9%. Should you make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule? Here is the cash flow timeline for this problem: Years 0 1 2 3 Cash Flow ($ million) - 95.3 Calculate the NPV of this investment opportunity if your cost of capital is 6.9%. 30.9 30.9 4 30.9 Forever 30.9arrow_forward
- Two new software projects are proposed to a young, start-up company. The Alpha project will cost $1,150,000 to develop and is expected to have annual net cash flow of $140,000. The Beta project will cost $1,200,000 to develop and is expected to have annual net cash flow of $150,000. The company is very concerned about their cash flow. Using the payback period, which project is better from a cash flow standpoint? Why?arrow_forwardYou are considering investing in a project related to a new product opportunity. If you undertake the project immediately, you calculate the NPV will be $165,000. If you postpone the decision for one year, you will learn more about the relevant manufacturing process as well as the market for your product. If you wait one year, you expect with 80 percent likelihood competitors will enter the market and your NPV (in one year) will be - $20,000. With 20 percent likelihood, you will be the only market player and you will improve your production technology to create an NPV (in one year) of $400,000. The appropriate discount rate is 11 percent. Required: Calculate the expected NPV if you defer the project for one year, regardless of the potential scenario. Calculate the expected NPV if you strategically decide how to undertake your project. That is, if we find that competitors enter the market, we can decide not to enter. Interpret the difference in your answers to parts 1 and 2.arrow_forwardYou are considering opening a new plant. The plant will cost $96.2 million upfront and will take one year to build. After that, it is expected to produce profits of $30.8 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 8.3%. Should you make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule? (...) Calculate the NPV of this investment opportunity if your cost of capital is 8.3%. The NPV of this investment opportunity is $ 246.44 million. (Round to two decimal places.) Should you make the investment? (Select the best choice below.) O A. Yes, because the project will generate cash flows forever. B. Yes, because the NPV is positive. C. No, because the NPV is less than zero. D. No, because the NPV is not greater than the initial costs. Calculate the IRR. The IRR of the project is%. (Round to two decimal places.)arrow_forward
- You are considering opening a new plant. The plant will cost $104.8 million upfront and will take one year to build. After that, it is expected to produce profits of $28.2 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 7.8%. Should you make the investment? Calculate the IRR. Does the IRR rule agree with the NPV rule?arrow_forwardYou are considering opening a new plant. The plant will cost $98.52 million up front and will take one year to build. After that, it is expected to produce profits of $30.46 million at the end of every year of production. The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 8.25%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. The NPV of the project will be $ million. (Round to two decimal places.)arrow_forwardIvy's Ice Cream is looking at an opportunity that would require an investment of $900,000 today. The investment will provide cash flows of $250,000 in the first year, $400,000 in the second year, and $600,000 in the third year. If the interest rate is 8%, what is the NPV of this investment opportunity? Should Ivy's Ice Cream move forward with this investment based on the NPV? (Round your answer to the nearest whole dollar.)arrow_forward
- You are considering opening a new plant. The plant will cost $104.1 million up front and will take one year to build. After that it is expected to produce profits of $29.6 million at the end of every year of production (starting two years from now). The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 7.6%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. The NPV of the project will be $ million. (Round to one decimal place) You make the investment. (Select from the drop-down menu.) Thearrow_forwardYou are considering opening a new plant. The plant will cost $102.6 million up front and will take one year to build. After that it is expected to produce profits of $30.9 million at the end of every year of production (starting two years from now). The cash flows are expected to last forever. Calculate the NPV of this investment opportunity if your cost of capital is 8.8%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. The NPV of the project will be $ million. (Round to one decimal place.) make the investment. (Select from the drop-down menu.) You The IRR is%. (Round to two decimal places.) The maximum deviation allowable in the cost of capital estimate is %. (Round to two decimal places.)arrow_forwardYou are considering opening a new plant. The plant will cost $103.4 million up front and will take one year to build. After that it is expected to produce profits of $29.6 million at the end of every year of production (starting two years from now). The cash flows are expected to last forever Calculate the NPV of this investment opportunity if your cost of capital is 8.3%. Should you make the investment? Calculate the IRR and use it to determine the maximum deviation allowable in the cost of capital estimate to leave the decision unchanged. Darrow_forward
arrow_back_ios
SEE MORE QUESTIONS
arrow_forward_ios
Recommended textbooks for you
EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning
Principles of Accounting Volume 2AccountingISBN:9781947172609Author:OpenStaxPublisher:OpenStax College
EBK CONTEMPORARY FINANCIAL MANAGEMENT
Finance
ISBN:9781337514835
Author:MOYER
Publisher:CENGAGE LEARNING - CONSIGNMENT
Intermediate Financial Management (MindTap Course...
Finance
ISBN:9781337395083
Author:Eugene F. Brigham, Phillip R. Daves
Publisher:Cengage Learning
Principles of Accounting Volume 2
Accounting
ISBN:9781947172609
Author:OpenStax
Publisher:OpenStax College
Capital Budgeting Introduction & Calculations Step-by-Step -PV, FV, NPV, IRR, Payback, Simple R of R; Author: Accounting Step by Step;https://www.youtube.com/watch?v=hyBw-NnAkHY;License: Standard Youtube License