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the firm should have included cannibalization of sales into its forecasts of existing products when the decision was originally made to accept those projects.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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ICE COMM 303 Suggested Solutions to Chapter 8 Problems -...

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