chapter11A

# chapter11A - Additional Solutions Chapter Eleven Dealing...

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Additional Solutions: Chapter Eleven: Dealing With Uncertainty 11S.1 The solution is shown in the accompanying spread-sheet, 11S1a.xls . Note that all values in columns to the right of column B are given in thousands of won. We see that the maximum income for both years is obtained at the same selling price, which is approximately 30 000. It is therefore unnecessary to bring this future income back to present value – since the future income for each selling price will be reduced by the same factor, the position of the optimum will not change. If we want to locate the optimum more precisely, we can make a simple change to the first column of the spreadsheet, examining a narrower range of pricing options on either side of the approximate optimum. This is done in the second spread-sheet, 11S1b.xls . Further refinement of the position of the optimum is not worthwhile, since the market research data we are using does not have perfect accuracy.

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*11S.2 Taking a ten-year study period, the initial expenses are the cost of the building and the machinery. We can represent the tax consequences of the straight-line depreciation of the building as a deduction of £( 0.04 ×1 000 000) from pre-tax income every year, but we will represent the after-tax cost of buying the machinery by multiplying its first cost by ( CCTF ), where the CCT F is defined by CCTF = 1-td/(i+d) = 0.5 ×0.25/(0.1+0.25) = 1-0.357 = 0.643 So the after-tax start-up cost of the project is: -1 000 000 – 500 000(1-0.357) The annual before-tax net income is: 2 000 000 – 40 000 – 50 ×30 000 So the after-tax income is: (2 000 000 – 40 000 – 50 ×30 000)(0.5) + 40 000 and the present worth of this income is: ((2 000 000 – 40 000 – 50 ×30 000)(0.5) + 40 000)( P/A ,0.1,10) So the total after-tax present worth of the project is: -1 000 000 – 500 000(1-0.357) + ((2 500 000 – 40 000 – 50 ×30 000)(0.5) + 40 000)( P/A ,0.1,10) This is calculated on the accompanying spreadsheet, 11S2.xls , and graphed in the chart below:
We see from this chart that the two most sensitive parameters are sales and labour costs; a small reduction in the sales volume could make the project unprofitable. It would be advisable to do further research on these two parameters before investing. 11S.3 We can solve the first part of this question by looking at a single year, since the cashflows are the same every year. Before the advertising campaign, Piet’s net income from pie sales is R 20 000 per month. To pay for the advertising campaign, he must pay an additional amount

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chapter11A - Additional Solutions Chapter Eleven Dealing...

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