BD_SM_c07

# BD_SM_c07 - Chapter 7 Fundamentals of Capital Budgeting 7-1...

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Chapter 7 Fundamentals of Capital Budgeting 7-1. a. Sales of new pizza – lost sales of original = 20 – 0.40(20) = \$12 million b. Sales of new pizza – lost sales of original pizza from customers who would not have switched brands = 20 – 0.50(0.40)(20) = \$16 million 7-2. 7-3. a. No, this is a sunk cost and will not be included directly. (But see (f) below.) b. Yes, this is a cost of opening the new store. c. Yes, this loss of sales at the existing store should be deducted from the sales at the new store to determine the incremental increase in sales that opening the new store will generate for HBS. d. No, this is a sunk cost. e. This is a capital expenditure associated with opening the new store. These costs will therefore increase HBS’s depreciation expenses. f. Yes, this is an opportunity cost of opening the new store. (By opening the new store, HBS forgoes the after- tax proceeds it could have earning by selling the property. This loss is equal to the sale price less the taxes owed on the capital gain from the sale, which is the difference between the sale price and the book value of the property. The book value equals the initial cost of the property less accumulated depreciation.) g. While these financing costs will affect HBS’s actual earnings, for capital budgeting purposes we calculate the incremental earnings without including financing costs to determine the project’s unlevered net income. Year 1 2 Incremental Earnings Forecast (\$000s) 1 Sales of Mini Mochi Munch 9,000 7,000 2O t h e r S a l e s 2 , 0 0 0 2,000 3 Cost of Goods Sold (7,350) (6,050) 4 Gross Profit 3,650 2,950 5 Selling, General & Admin. (5,000) - 6 Depreciation - - 7 EBIT (1,350) 8 Income tax at 35% 473 (1,033) 9 Unlevered Net Income (878) 1,918

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66 Berk/DeMarzo Corporate Finance 7-4. a. Change in EBIT = Gross profit with price drop – Gross profit without price drop = 25,000 × (300 – 200) – 20,000 ×(350 – 200) = - \$500,000 b. Change in EBIT from Ink Cartridge sales = 25,000 × \$75 × 0.70 – 20,000 × \$75 × 0.70 = \$262,500 Therefore, incremental change in EBIT for the next 3 years is Year 1: \$262,500 – 500,000 = -\$237,500 Year 2: \$262,500 Year 3: \$262,500 7-5.
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## This note was uploaded on 10/08/2010 for the course ENGIN 120 taught by Professor Ilan during the Spring '08 term at Berkeley.

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BD_SM_c07 - Chapter 7 Fundamentals of Capital Budgeting 7-1...

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