ICE COMM 303 Suggested Solutions to Chapter 8 Problems

ICE COMM 303 Suggested Solutions to Chapter 8 Problems -...

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Chapter 8: Cash Flow and Capital Budgeting Answers to Problems 8-2. a. The terminal value is: [\$2.5 million *(1 + 4%)] ÷ [15% - 4%] = \$23.64 million. b. The total value of the cash flows is: [\$1.2 million ÷ (1 + 15%)] + [\$1.4 million ÷ (1 + 15%) 2 ] + [\$1.7 million ÷ (1 + 15%) 3 ] + [\$2 million ÷ (1 + 15%) 4 ] + [(\$2.5 million + \$23.64 million) ÷ (1 + 15%) 5 ] = \$17.36 million. c. The terminal value accounts for 67.7% of the total value of the cash flows ([\$23.64 million ÷ (1 + 15%) 5 ] ÷ \$17.36 million). 8-5. Initial NPV = -\$10 million + [\$5.6 million ÷ (1 + 12%)] + [\$6.272 million ÷ (1 + 12%) 2 ] + [\$7.025 million ÷ (1 + 12%) 3 ] = \$5.00 million. NPV for Year 3 cash flow = -\$6 million + [\$6.6 million ÷ (1 + 12%)] = -0.107 million. Because the NPV is negative, the firm should not continue the project. Notice, the past performance of the project (although successful) is not a factor in making this decision. 8-12. Incremental operating cash flows Year 2005 2006 2007 2008 2009 Change in sales \$2,000,000 \$4,000,000 \$6,000,000\$10,000,000\$14,000,000 – Change in expenses (90%) 1,800,000 360,0000 540,0000 900,0000 12,600,000 – Advertising expense 3,000,000 3,000,000 3,000,000 3,000,000 3,000,000 Change in taxable income \$–2,800,000\$–2,600,000\$–2,400,000\$–2,000,000\$–1,600,000 – Taxes (40%) –1120000 –1040000 –960000 –800000 –640000 Incremental Opr. CFs \$–1,680,000 \$–1,560,000 \$–1,440,000 \$–1,200,000 \$–960,000 The proposed campaign would not generate enough in new sales revenues to justify the additional advertising expense. 8-14. Sunk costs include: a. Research and development funds already spent Relevant costs include: b. The impact on other products produced by the company. However, since it is expected that the competition will erode sales if Blueberry does not do so itself, then a case could be made that the firm should have included cannibalization of sales into its forecasts of existing products when the decision was originally made to accept those projects. c.

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This note was uploaded on 03/18/2008 for the course ICE 303 taught by Professor Roberts during the Spring '08 term at UVA.

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ICE COMM 303 Suggested Solutions to Chapter 8 Problems -...

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