Information Business Scenarios Product Unit Selling Likelihood Demand Price

Information business scenarios product unit selling

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somewhere between 10% and 14%. Information Business Scenarios: Product Unit Selling Likelihood Demand Price Optimistic 0.50 100,000 $80.00 Pessimistic 0.50 40,000 $70.00 Estimated cost data: Variable cost per unit = $40.00 Manufacturing equipment: Acquisition cost = $12,000,000 Usefule life (years) = 10 Estimated salvage = $0 Abandonment value, end of year 1 $10,400,000 Estimated Income-Tax Rate = 33.33% Possible discount rates: 10.00% 11.00% 12.00% 13.00% Requirements
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1. What is the anticipated after-tax cash flow for this investment for each of the states of nature/scenarios? 2. Under the assumption that the two scenarios (level of product demand) are what is the expected NPV of the proposed investment? Assume a discount Based on the amount you estimated, should you invest in the project? 3. How senstive is your decision to the assumption regarding the discount rate this question, prepare an estimated NPV for the proposed project using disc 1% increments, from 10% to 14%. Is the decision to accept or reject the inve sensitive to the discount rate used in the calculation of NPV? 4. Suppose your company could abandon the project and dispose of the manu equipment for $10.4 million if demand for your product turns out to be weak colleagues would make this decision at the end of the first year of operation Solution 1. Annual after-tax cash flows, both scenarios (possible outcomes): Product Demand Optimistic Pessimistic Selling price/unit $80.00 $70.00 Variable cost/unit $40.00 $40.00 CM/unit $40.00 $30.00 Volume (units) 100,000 40,000 Pre-tax Cash Flow $4,000,000 $1,200,000 Less: Depreciation $1,200,000 $1,200,000 Pre-tax Income $2,800,000 $0 Taxes $933,333 $0 After-tax Income $1,866,667 $0 Plus: Depreciation $1,200,000 $1,200,000 Net Cash Inflow $3,066,667 $1,200,000 2. Expected NPVs Year After-tax Cash Inflows 1 $3,066,667 $1,200,000 2 $3,066,667 $1,200,000 3 $3,066,667 $1,200,000 4 $3,066,667 $1,200,000 5 $3,066,667 $1,200,000 6 $3,066,667 $1,200,000 the abandonment option change your decision whether to invest in the proje a discount rate of 12%.)
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7 $3,066,667 $1,200,000 8 $3,066,667 $1,200,000 9 $3,066,667 $1,200,000 10 $3,066,667 $1,200,000 PV of Cash Inflows $17,327,351 $6,780,268 Initial Investment Outlay $12,000,000 $12,000,000 NPV $5,327,351 ($5,219,732) = $53,809 Strictly speaking, the project would be accepted because its expe positive. However, the expected NPV is close to zero; in fact, it's "toss up" as to whether or not this project is profitable in a presen 3. Sensitivity Analysis Results: WACC Expected NPV 10% $1,108,410 11% $563,695 12% $53,809 13% ($424,014) 14% ($872,287) As can be seen from the above summary table, the Expected NPV (given a probabilities for each outcome/state-of-nature) is sensitive to the assumptio the discount rate. 4. Effect of abandonment value: Abandonment value, end of year 1 $10,400,000 Cash flow, end of year 1: After-tax operating cash flow $1,200,000 Gross proceeds, equipment $10,400,000 Less: NBV, end of year 1 $10,800,000 Gain (Loss) on Sale ($400,000) Tax Effect of Sale ($133,333) $10,533,333 Total cash flow, end of year 1 $11,733,333 $10,476,190 Expected NPV = (0.50 × $5,327,351) + (0.50 × ($5,219,732)) PV ( t = 0) of Total Cash Flow, Year 1 =
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NPV of project, with abandonment option: PV of Total Cash Flow, Year 1 $10,476,190 $12,000,000 NPV, abandonment scenario = ($1,523,810) Expected NPV of investment, with abandonment option: Scenario Prob. NPV Weighted NPV Optimistic 0.50 $5,327,351 $2,663,675 Pessimistic 0.50 ($1,523,810) ($761,905) Expected NPV = $1,901,771 Note that the abandonment option adds considerable value to the proposed demand turns out to be "pessimisstic," then the company can minimize its l abandoning the project at the end of year 1. As you can see, the NPV in the scenario is negative $1,523,810. Compare this amount to the orginal value
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