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Unformatted text preview: a new conveyor system.
Management must choose among three alternative courses of action: (1) The
firm can sell the design outright to another corporation with payment over 2
years. (2) It can license the design to another manufacturer for a period of 5
years, its likely product life. (3) It can manufacture and market the system itself.
The company has a cost of capital of 12%. Cash flows associated with each
alternative are as follows:
Initial investment (CF0)
Year (t) Sell License Manufacture $200,000 $200,000 $450,000 Cash inflows (CFt) 1 $200,000 $250,000 2 250,000 100,000 $200,000
250,000 3 — 80,000 200,000 4 — 60,000 200,000 5 — 40,000 200,000 6 — — 200,000 a. Calculate the net present value of each alternative and rank the alternatives
on the basis of NPV.
b. Calculate the annualized net present value (ANPV) of each alternative and
rank them accordingly.
c. Why is ANPV preferred over NPV when ranking projects with unequal lives? 460 PART 3 LG6 Long-Term Investment Decisions 10–14 Real options and the strategic NPV Jenny Rene, the CFO of Asor Products,
Inc., has just completed an evaluation of a proposed capital expenditure for
equipment that would expand the firm’s manufacturing capacity. Using the traditional NPV methodology, she found the project unacceptable because
NPVtraditional $1,700 $0 Before recommending rejection of the proposed project, she has decided to assess
whether there might be real options embedded in the firm’s cash flows. Her evaluation uncovered the following three options.
Option 1: Abandonment—The project could be abandoned at the end of 3
years, resulting in an addition to NPV of $1,200.
Option 2: Expansion—If the projected outcomes occurred, an opportunity to
expand the firm’s product offerings further would occur at the end of 4 years.
Exercise of this option is estimated to add $3,000 to the project’s NPV.
Option 3: Delay—Certain phases of the proposed project could be delayed if
market and competitive condition...
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This document was uploaded on 01/19/2014.
- Fall '13