Chapter7 - Problems

# Chapter7 - Problems - 1 2 3 Forecasting risk is the risk...

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1. Forecasting risk is the risk that a poor decision is made because of errors in projected cash flows. The danger is greatest with a new product because the cash flows are probably harder to predict. 2. With a sensitivity analysis, one variable is examined over a broad range of values. With a scenario analysis, all variables are examined for a limited range of values. 3. It is true that if average revenue is less than average cost, the firm is losing money. This much of the statement is therefore correct. At the margin, however, accepting a project with marginal revenue in excess of its marginal cost clearly acts to increase operating cash flow. 4. From the shareholder perspective, the financial break-even point is the most important. A project can exceed the accounting and cash break-even points but still be below the financial break-even point. This causes a reduction in shareholder (your) wealth. 5. The project will reach the cash break-even first, the accounting break-even next and finally the financial break-even. For a project with an initial investment and sales afterwards, this ordering will always apply. The cash break-even is achieved first since it excludes depreciation. The accounting break-even is next since it includes depreciation. Finally, the financial break-even, which includes the time value of money, is achieved.

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Problem #1 Units 75000 Price \$39 Variable Cost \$23 Cap Ex \$724,000 Depreciation / Yr \$90,500 Fixed Costs/Yr \$850,000 a) Accounting Break Even (FC + Depreciation) / (Price - VC) 58,781 units b) 0 1 2 3 4 5 6 7 8 Sales \$2,925,000 \$2,925,000 \$2,925,000 \$2,925,000 \$2,925,000 \$2,925,000 \$2,925,000 \$2,925,000 Var Cost \$(1,725,000) \$(1,725,000) \$(1,725,000) \$(1,725,000) \$(1,725,000) \$(1,725,000) \$(1,725,000) \$(1,725,000) Fixed Costs \$(850,000) \$(850,000) \$(850,000) \$(850,000) \$(850,000) \$(850,000) \$(850,000) \$(850,000) Depreciation \$(90,500) \$(90,500) \$(90,500) \$(90,500) \$(90,500) \$(90,500) \$(90,500) \$(90,500) EBIT \$- \$259,500 \$259,500 \$259,500 \$259,500 \$259,500 \$259,500 \$259,500 \$259,500 Taxes \$- \$(90,825) \$(90,825) \$(90,825) \$(90,825) \$(90,825) \$(90,825) \$(90,825) \$(90,825) NOPAT \$- \$168,675 \$168,675 \$168,675 \$168,675 \$168,675 \$168,675 \$168,675 \$168,675 Adjustments: (+) Depreciation \$- \$90,500 \$90,500 \$90,500 \$90,500 \$90,500 \$90,500 \$90,500 \$90,500 (-) Chgs in NWC (-) Cap Ex \$(724,000) (+) Salvage Value Free Cash Flow \$(724,000) \$259,175 \$259,175 \$259,175
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Chapter7 - Problems - 1 2 3 Forecasting risk is the risk...

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