Ross5eChap09sm - Chapter 9 Risk Analysis Real Options and...

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Answers to End–of–Chapter Problems B–1 Chapter 9: Risk Analysis, Real Options, and Capital Budgeting 9.2 Calculate the NPV of each option. The manager should pursue the option with the highest NPV. NPV(Go Directly) = C Success (Prob. of Success) = $1,200,000 (0.50) = $600,000 The NPV of going directly to market is $600,000. NPV(Focus Group) = C 0 + C Success (Prob. of Success) = –$120,000 + $1,200,000 (0.70) = $720,000 The NPV when conducting a focus group is $720,000. NPV(Consulting Firm) = C 0 + C Success (Prob. of Success) = –$400,000 + $1,200,000 (0.90) = $680,000 The NPV when hiring a consulting firm is $680,000. The firm should conduct a focus group since that option has the highest NPV. 9.4 Carl should have taken the $7,000. Expected return for 1% of movie profits is $3,952. Since only good scripts are made into movies and only a good movie would make a profit: (13% x 32% x $9.5 mil x 1%) Movie studio decision tree: 9.6 a. The accounting breakeven is the aftertax sum of the fixed costs and depreciation charge divided by the contribution margin (selling price minus variable cost). In this case, there are no fixed costs, and the depreciation is the entire price of the press in the first year. So, the accounting breakeven level of sales is: Q A = [(FC + Depreciation)(1 – Tc)] / [(P – VC)(1 – Tc)] Q A = [($0 + 2,000) (1 – 0.30)] / [($10 – 8) (1 – 0.30)] Script is bad Don’t make movie 87% No profit Read script Script is good Make Movie Movie is good Movie is bad Big Audience Small Audience 13% 32% 68% Profit = $9.5 milli No Profit
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Answers to End–of–Chapter Problems B–2 Q A = 1,000 units b. When calculating the financial breakeven point, we express the initial investment as an equivalent annual cost (EAC). The initial investment is the $10,000 in licensing fees. Dividing the in initial investment by the three–year annuity factor, discounted at 12 percent, the EAC of the initial investment is: EAC = Initial Investment / 3 12 . 0 A EAC = $10,000 / 2.4018 EAC = $4,163.49 Note, this calculation solves for the annuity payment with the initial investment as the present value of the annuity, in other words: PV= C({1 – [1/(1 + r)] t } / r) $10,000 = C{[1 – (1/1.12) 3 ] / .12} C = $4,163.49 Now we can calculate the financial breakeven point. Notice that there are no fixed costs or depreciation. The financial breakeven point for this project is: Q F = [EAC + FC(1 – Tc) – Depreciation(Tc)] / [(P – VC)(1 – Tc)] Q F = ($4,163.49 + 0 – 0) / [($10 – 8) (.70)] Q F = 2,973.92 or about 2,974 units 9.8 Apply the accounting profit break–even point (BEP) formula and solve for the sales price, x , that allows the firm to break even when producing 24,000 calculators. In order for the firm to break even, the revenues from the calculator sales (number of calculators sold × sales price per unit) must equal the total annual cost of producing the calculators. Remember to include taxes in the analysis.
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