case2_03

case2_03 - Capital budgeting with staged entry Financial...

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Capital budgeting with staged entry Financial management and policy Case 2, week 3 University of Maastricht Faculty of Economics and Business Administration Maastricht, 12 th of November 2003 Danner, W. I 136964 Kuijt, R.J. I 130885 Steenvoorden, W.J.M. I 178829 Course Code: 6010v Group number: 7 Subgroup number: 1 Tutor: B. Pavlov
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1) a) What cost, if any should be attributed to the trout project, concerning land acquisition? The costs that should be attributed to the trout project amounts $ 900.000, because suitable sites can be purchased for this amount. The option doesn’t have to be taken into account, since it concerns an option Atlantic inc. has to acquire additional land for the Salmon Division. If the land is used for the trout project, Salmon Division should purchase a new site by exercising the option. The option (paying $ 60.000 in December 1996 and $ 1.000.000 in December 2000) is more valuable than buying land today for a price of $ 900.000. This can be examined in the following calculation: b) What discount rate should be used in analyzing the option alternative? $ 900.000 * 1,06 4 = $ 1.136.229 (6% is the annual appreciation of land) $ 1.136.229 - $ 1.000.000 / (1,04) 4 = $ 116.449 (Opt. val. – init. Inv. disc. by the an. infl. rate) $ 116.449 - $ 60.000 = $ 56.449 (Option gain - option price = option value) By exercising the option, the Salmon Division would obtain a profit of $ 56.449, compared to buying land for $ 900.000 today. Additional to this, with the option the Salmon Division can decide whether or not to continue the project, depending on development of market circumstances. The discount rate used in the calculation is the inflation rate, which was assumed to be the risk free rate. 2) a) What would be the R&D cash flows be in 1998 through 2000. Should the R&D cash flow for 1996 be included in the calculations as well? The R&D cash flows that should be taken into account for the years 1998 to 2000 are $ 360.000. This amount is amortized over three years and therefore the annual amortization expense for R&D amounts to $ 120.000. The initial R&D cash was $ 600.000 in 1996, of which $ 240.000 was expensed immediately for tax purposes. Therefore these $ 240.000 are not considered in the years of analysis. b) How is salvage value taxed? According to the 31.5-depreciation method, the market value for the building under Plan L amounts $ 2.389.179 after seven years. With respect to the building under Plan S, a market value of $ 3.062.905 can be calculated over the same period of time, including the building expansion after the third year. Given that the salvage value is half of the buildings book value, 2
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this means that a loss would arise from selling the building under both plans being $ 889.179 and $ 1.262.905 respectively. Taxation of salvage value is dependent on prescribed tax regulation. Whether the occurred
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case2_03 - Capital budgeting with staged entry Financial...

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