Concept explainers
(Real options and capital budgeting) Go-Power Batteries has developed a high-voltage nickel–metal hydride battery that can be used to power a hybrid automobile. It can sell the technology immediately to Toyota for $10 million, or alternatively, Go-Power Batteries can invest $50 million in a plant and produce the batteries for itself and sell them. Unfortunately, given the current size of the market for hybrids, the present value of the cash flows from such a plant would be only $40 million, implying that the plant has a negative expected
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Foundations Of Finance
- An auto plant that costs $100 million to build can produce a line of flexfuel cars that will produce cash flows with a present value of $140 million if the line is successful but only $50 million if it is unsuccessful. You believe that the probability of success is only about 50%. You will learn whether the line is successful immediately after building the plant. a-1.Calculate the expected NPV. (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Enter your answer in millions.) a-2.Would you build the plant? Suppose that the plant can be sold for $95 million to another automaker if the auto line is not successful. b-1. Calculate the expected NPV. (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Enter your answer in millions rounded to 1 decimal place.) b-2. Would you build the plant?arrow_forwardAn auto plant that costs $140 million to build can produce a line of flexfuel cars that will produce cash flows with a present value of $200 million if the line is successful but only $60 million if it is unsuccessful. You believe that the probability of success is only about 40%. You will learn whether the line is successful immediately after building the plant. a-1. Calculate the expected NPV. (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Enter your answers in millions rounded to 1 decimal place.) a-2. Would you build the plant? Suppose that the plant can be sold for $135 million to another automaker if the auto line is not successful. (Do not round intermediate calculations. A negative amount should be indicated by a minus sign. Enter your answers in millions rounded to 1 decimal place.) b-1. Calculate the expected NPV. b-2. Would you build the plant?arrow_forwardVerizon has spent billions of dollars to upgrade its network from 3G to 4G. But there aren't many 4G compatible devices, coverage is spotty, and most applications don't really need higher speeds. Verizon is hoping that its investment in 4G works out. Based on the potentially slow initial adoption of 4G by customers, how might the conclusions of a cash payback analysis of Verizon's 4G investment differ from a present value analysis?arrow_forward
- A venture capital investment group received a proposal from Wireless Solutions to produce a new smartphone. The variable cost per unit is estimated at $250, the sales price would be set at twice the VC/unit, fixed costs are estimated at $750,000, and the investors will put up the funds if the project is likely to have an operating income of $500,000 or more. What would sales volume (units) be required to meet this profit goal?arrow_forward(Calculating free cash flows) At present, Solartech Skateboards is considering expanding its product line to include gas-powered skateboards; however, it is questionable how well they will be received by skateboarders. Although you feel there is a 70 percent chance you will sell 11,000 of these per year for 10 years (after which time this project is expected to shut down because solar-powered skateboards will become more popular), you also recognize that there is a 15 percent chance that you will only sell 2,000 and also a 15 percent chance you will sell 16,000. The gas skateboards would sell for $140 each and have a variable cost of $30 each. Regardless of how many you sell, the annual fixed costs associated with production would be $150,000. In addition, there would be an initial expenditure of $1,100,000 associated with the purchase of new production equipment which will be depreciated using the bonus depreciation method in year 1. Because of the number of stores that will need…arrow_forwardSunshine Smoothies Company (SSC) manufactures and distributes smoothies. It is considering the introduction of a "weight loss" smoothie. The project would require a $4 million investment outlay today (t = 0). The after-tax cash flows would depend on whether the weight loss smoothie is well received by consumers. There is a 30% chance that demand will be good, in which case the project will produce after-tax cash flows of $2 million at the end of each of the next 3 years. There is a 70% chance that demand will be poor, in which case the after-tax cash flows will be $1 million for 3 years. The project is riskier than the firm's other projects, so it has a WACC of 12%. The firm will know if the project is successful after receiving first year's cash flows. After receiving the first year's cash flows it will have the option to abandon the project. If the firm decides to abandon the project the company will not receive any cash flows after t = 1 , but it will be able to sell the assets…arrow_forward
- (Calculating free cash flows) At present, Solartech Skateboards is considering expanding its product line to include gas-powered skateboards; however, it is questionable how well they will be received by skateboarders. Although you feel there is a 60 percent chance you will sell 8,000 of these per year for 10 years (after which time this project is expected to shut down because solar-powered skateboards will become more popular), you also recognize that there is a 20 percent chance that you will only sell 1,000 and also a 20 percent chance you will sell 18,000. The gas skateboards would sell for $110 each and have a variable cost of $35 each. Regardless of how many you sell, the annual fixed costs associated with production would be $120,000. In addition, there would be an initial expenditure of $1,000,000 associated with the purchase of new production equipment which will be depreciated using the bonus depreciation method in year 1. Because of the number of stores that will need…arrow_forwardZuti has a capital investment project that could start immediately. The project will require a machine costing $2.4 million. The total discounted value now of the cash inflows from the project will be either $2.6 million or $1.9 million with equal probability. The risk-free rate is 3%. Instead of starting immediately the project could be delayed until one year from now to gain more market information. Its total discounted cash inflows at that time will be known as either $2.6 million, or $1.9 million, with certainty. (i) What is the present value of the option to delay? (ii) The supplier of the machine has offered to deliver it (if required) in one year's time at a price of only $2 million, if Zuti pays a non-refundable deposit now. What is the maximum the firm should pay as a deposit now? What type of real option does this represent for Zuti? Identify the specific components of the option contract.arrow_forwardou are considering setting up a firm to produce widgets. The cost of the project is $30 today. The demand for widgets is uncertain. It can be either high or low with equal probability. When the demand is high, cash flows in t = 1 are $66 and when the demand is low, cash flows in t = 1 are $34. The discount rate is 10%. What is the NPV of the project? Suppose you can commission a study that tells you whether the demand for widgets will be high or low. The study takes one year to complete. That is, if you commission the study you must decide in t = 1 whether to invest. If you invest the cash flows will arrive in t = 2. What is the maximum amount you are willing to pay for the study today?arrow_forward
- Two new software projects are proposed to a young, start-up company. The Delta project will cost $150,000 to develop and is expected to have annual net cash flow of $40,000. The Echo project will cost $200,000 to develop and is expected to have annual net cash flow of $50,000. The company is very concerned about their cash flow. Using the payback period, which project is better from a cash flow standpoint? Why? Present the payback period for each project. Use this formula: Payback period = Investment/Annual Savingsarrow_forwardAll American Telephones Inc. is considering the production of a new cell phone. The project will require an after-tax investment of $13 million. If the phone is well received, the project will produce after-tax cash flows of $9 million a year for 3 years, but if the market does not like the product, the after-tax cash flows will be only $1 million per year. There is a 50% probability of both good and bad market conditions. All American can delay the project a year while it conducts a test to determine whether demand will be strong or weak. The delay will not affect the dollar amounts involved for the project's after-tax investment or its after-tax cash flows-only their timing. Because of the anticipated shifts in technology, the 1-year delay means that after-tax cash flows will continue only 2 years after the initial investment is made. All American's WACC is 13%. What action do you recommend? Enter your answers in millions. For example, an answer of $10,550,000 should be entered as…arrow_forwardTyler, Inc., is considering switching to a new production technology. The cost of the required equipment will be $3,529,783 . The discount rate is 13.99 percent. The cash flows that the firm expects the new technology to generate are as follows. a. Compute the payback and discounted payback periods for the project. b. What is the NPV for the project? Should the firm go ahead with the project? c. What is the IRR, and what would be the decision based on the IRR? Years CF 0 $(3,529,783) 1-2 0 3-5 $916,204 6-9 $1,590,056arrow_forward
- EBK CONTEMPORARY FINANCIAL MANAGEMENTFinanceISBN:9781337514835Author:MOYERPublisher:CENGAGE LEARNING - CONSIGNMENTIntermediate Financial Management (MindTap Course...FinanceISBN:9781337395083Author:Eugene F. Brigham, Phillip R. DavesPublisher:Cengage Learning